Yet Another Value Podcast - Daniel Payne from ICBLA on $COIN v. SEC (sponsored by Stream by AlphaSense)

Episode Date: July 25, 2023

Our podcast sponsor, Stream by Alphasense, connected us with Daniel Payne, Senior Fellow at the International Congress of Blockchain Legal Advisors, to discuss the stakes at play in the SEC vs. Coinbase $COIN case. International Congress of Blockchain Legal Advisors Website: https://icbla.legal/ Chapters: [0:00] Introduction + Episode sponsor: Stream by Alphasense [1:08] Daniel Payne quick background [4:23] SEC vs. Coinbase $COIN - high level overview of the case [8:45] What are the stakes the SEC is playing for here? [11:11] $COIN response to the SEC [18:09] $COIN on the regulatory uncertainty [22:57] Ripple decision and how this impacts the $COIN case [29:51] Congress working towards legislation of crypto and how that affects $COIN case [32:57] $COIN's S-1 Defense [36:43] Two allegations the SEC is leveling against $COIN [39:55] Staking program and what the SEC is alleging about this program [47:15] Likelihood of certain tokens becoming securities [49:08] $COIN lingering liabilities from operating a commodities exchange without proper regulation? [50:44] SEC argument on $COIN's internal Howey Test for allowing various tokens to trade on their platform [53:04] SEC vs. $COIN case timing and final thoughts Today's episode is sponsored by: Stream by Alphasense Are traditional expert calls in the investment world becoming obsolete? According to Stream, they are, and you can access primary research easily and efficiently through their platform. With Stream, you'll have the right insights at your fingertips to make the best investment decisions. They offer a vast library of over 26,000 expert transcripts, powered by AI search technology. Plus, they provide competitive rates on expert call services, and you can even have an experienced buy-side analyst conduct the calls for you. But that's not all. Stream also provides the ability to engage with experts 1-on-1 and get your calls transcribed free-of-charge—all for 40% less than you would pay for 20 calls in a traditional expert network model. So, if you're looking to optimize your research process and increase ROI on investment research spend, Stream has the solution for you. Head over to their website at streamrg.com to learn more. Thanks for listening, and we'll catch you next time. For more information: https://www.streamrg.com/

Today's podcast is sponsored by Stream. I've been looking deeply at the SEC's litigation against Coinbase, and Stream was kind enough to introduce me to a crypto lawyer to have this conversation with and to dive deeply into the themes and topics and the suits. If you like this conversation, you can find many more like it by checking out Stream's expert call library. Please see the link in the show notes. All right, hello, and welcome to the Yet Other Value Podcast.

I'm your host, Andrew Walker. If you like this podcast, would mean a lot if you could follow, rate, subscribe, review us, wherever you're watching or listening to us with me today. Happy to have Daniel Payne. Daniel is a senior fellow at the International Congress of Blockchain Legal Advisors. The website there is ICBLA.org. Did I get that right, Daniel? You got it right. Yeah. Great. Daniel, how's it going? It's going great. Really glad to be here. I'm really looking forward to this one. Before we get started, I just want to remind everyone a quick disclaimer that nothing on this podcast is investing in advice. We're really going to be talking about

a legal case today. But just please remember, we're obviously talking about at least one publicly traded company. Nothing here is investing advice. Please consults financial advisor and do your own due diligence. Daniel, the reason we kind of got connected is I was talking with stream. I told them, hey, I think one area of real interest is this Coinbase versus SEC suit complaint. SEC is kind of coming out for the death now for Coinbase. And Coinbase had a really interesting response about a week or so ago. So they connected us to get some more information on kind of the case and a actual kind of, I said, crypto lawyer when I was talking to a crypto lawyer's perspective on the case. So I'll just pause there. If you want to talk a little bit

about your background, you can, or we can just start diving right into the case and kind of your views on it. Yeah, let me give a quick brief background. I love that you're very careful disclaiming. There's no financial advice here. I knew a lawyer would love to have a disclaimer right at the start. How many disclaimers can we put out there? So I will also add that nothing I say should be construed as legal advice. We're commenting on publicly filed litigation. If you've got any legal questions, you should absolutely consult your own lawyer. But let me give a quick introduction of who I am and my background and what makes me a crypto attorney. Because, yeah, there's very few, you know, really dedicated crypto attorneys who aren't doing anything else.

So how in the world did I find myself in this role? I can tell you it's not because I learned anything about this in law school, you know, a decade and a half ago. It didn't exist back then. And very few law students are learning about this in law school right now. So my background is as a securities attorney. So I worked at a boutique law firm that focused on securities regulation and securities litigation. We handled a lot of mortgage-backed security cases arising out of the financial crisis and did that for a long time. We represented banks, broker dealers, all sorts.

of financial services companies. In about 2017, some of our major cases were rolling off, and we pivoted into the crypto space. So there were, this is back with the ICO mania, ICO summer, and the overwhelming majority of projects then had absolutely no interest in whether or not they were complying with the securities laws or needed to. They didn't care. This was just a really cool thing they could do. there were a small, there was a small subset that said, hey, we actually believe in these projects and we'd like an experienced securities attorney to advise us on the risks here and what we might need to do to comply. So they found us. They educated us. And that was our introduction into the space. And so that's how I found myself in the space. And from there, I built a practice in the crypto space. And a couple years ago, one of my

clients hired me in-house from the firm. And so now, in addition to being a senior fellow at ICBLA, I act as in-house counsel for an ecosystem of crypto companies that are building out layer two blockchains on Ethereum and doing a lot of cool stuff. But that's where I am today. That's the short version of how I became a crypto attorney. No, look, that's great. And when I was talking to stream about potential, again, I said, hey, can you find me a crypto lawyer? There were not a lot. there. And obviously your background in securities law makes it really interesting for this case because a lot of this case rests on how we test. Is it a security or is it not? Like a lot of

those things. So I thought that was a perfect background. Yeah, let's use that to just pivot. The SEC gives a well's notice to Coinbase, I think, in March. They come out with a suit in June. Coinbase files a response to them in July. I guess just high level. Maybe you could walk through what the SEC is alleging and what the Coinbase and what Coinbase is kind of hitting them back with before we start getting into your views and different pieces of the case. Right. So the complaint is 100 pages long. It's not a quick and dirty 15 page pager. They get into some detail. But it's a pretty straightforward case in terms of what they're alleged. So Coinbase, as most people probably watching this, no, offers a secondary market for digital assets

to be traded. So they're a digital asset exchange and there's ancillary services that they offer, but that's the core of what they do. And they've done that for a long, long time, many, many years. They're the only publicly traded digital asset exchange in the U.S. There are plenty of other digital asset exchanges operating in the U.S. This is the only public company there, and that's a critical point in this case, is the fact that they're public and they filed an S-1 that was approved by the SEC. So the complaint alleges now that the SEC's view is that this exchange, this digital asset exchange, is an unregistered securities exchange. And all that means is that the digital assets on the exchange, at least some of them, the SEC is

now alleging our securities. And if you provide an exchange to match buyers and sellers of securities, then you have to register with the SEC as a national securities exchange. That's pretty straightforward. So that's the heart of the complaint. Now, there are also claims that the SEC, sorry, the Coinbase should have registered as a broker and should have registered as a clearing agency. And those requirements generally go along with the services that are provided that the Coinbase is providing to execute the trades on their platform. There's a couple of other claims that Coinbase's parent CGI is controlling Coinbase and they have control person liability, but there's not really separate allegations for that substantively. So the

the complaint summarizes Coinbase's operations, and then the theory is that the digital assets are securities, and what will follow from that are these registration requirements. There's one last piece here is Coinbase's staking operation, and so they allege that the staking operation that Coinbase offers is an unregistered security that Coinbase is offering directly. Now, so that's about half of the complaint is laying out those facts. The second half is actually a deep dive into 12 of the digital assets that the SEC says are securities. And what the SEC has to do in the complaint is allege sufficient facts to demonstrate that each of these digital assets qualify as investment contracts, securities under Howie, in order to make their claim. Now, there's, of course, an open question as to the other two. 200 plus digital assets on there, I guess other than Bitcoin and Ethereum, whether they are securities or not, and we'll get more into that because we've got some more information on that outside of the complaint. So that's what the SEC hit Coinbase with. And Coinbase

has adopted an aggressive confrontational posture. Just before we get to Coinbase posture, if the SEC is right, right? And let's say every claim they make is right. Staking is an unregistered security. They're operating a unlicensed exchange, all this. What are the penalties for Coinbase? Is it the whole company's bankrupt and there's zero recovery for everyone? Is it a big fine? Is it somewhere in between? What would the, what are what are the stakes the SEC's playing for here? Well, it's it's very, very high stakes, but it's unclear if the SEC proves what's in the complaint, what would happen. Yeah.

Because, again, they've only alleged these 12 are securities. We don't know what their plans are as to the other 200. Could Coinbase delist those 12, pay some penalties, and proceed as an unregistered exchange, and be okay? Or is the SEC planning to add more digital assets as the case goes along? Would the court let the SEC get away with reserving judgment? on the rest of the digital assets. You don't know that. The judge actually asked the SEC this at a hearing last week.

And the SEC didn't answer. They don't have an answer yet on what they're planning to do. In their view, if they prove that one of these 12, if there's a single digital asset security on Coinbase's platform, then they win and they can get these penalties. But what they haven't grappled with is then what? What happens next? Because Coinbase could delist it, right? And one option would be Coinbase just comes in and tries to register. And Coinbase's position is that's impossible. You can't list commodities and securities on the same platform under the registration protocol. So what would they actually be able to do? Nobody knows. I guess maybe the SEC thinks they need to shut down. So it's not clear. It's really, really not clear.

Of course, if the SEC prevails on some theories or at least some tokens, there will be some penalties, some disgorgement, thought to pay something. But what does Coinbase look like after that is really an open question. And that's because the SEC hasn't grappled with really what they're doing in this complaint. Perfect. And I think that's a great transition. You were going to get into it before I just wanted to clarify. but Coinbase came out with a really strong and really interesting response last week.

Do you want to go through kind of how Coinbase has responded to the SEC? Yeah, absolutely, because this is, this is, I won't be too personal here. But speaking for the industry, it's generally very heartening to see a well-funded defendant that can really fight back at the highest level. They've hired expert attorneys from very well-known name brand law firms, in New York, who will provide them the absolute best defense, just as, just as Ripple have received and they, you know, saw the benefits of that. But they're not sitting back and filing an answer and saying, let's go to discovery and maybe in a couple years after we've bled out $200 million

in legal fees. We'll try some rejudgment and then we'll go to trial in five years. That's not the position at all. They have come back. and said, the SEC is striking at the heart of our business. We don't have, this is existential. And it impacts not just us, but the entire crypto community. So we deserve an answer quickly. And they have teed the court up to answer this quickly. Now, just as an aside, again, there was a hearing last week and the judge said, well, not so fast.

I've got some other things going on on my docket. So I can't give you guys an answer next week. But it's definitely going to be expedited. And the judge recognized that that's what the parties, at least the Coinbase was looking for. So two things here. One is before the case was even filed, they had actually taken a step to start their defense. They filed an action against the SEC in the Third Circuit. They filed a petition for a writ of mandamus.

Now, I will take this interview off on a sidetrack here, but suffice it to say, that was really the beginning of their defense, is they told that appellate court, that's a circuit court of appeals, they told that court, hey, we asked the SEC for clarity on whether they're planning to do rulemaking in this space or not. And the SEC hasn't said yes or no. They put it in their back pocket. So they asked the court to force the SEC to answer. sir. And look, this is, this would be unusual relief to get it. Mandamus is a, courts are loath to order mandamus against the government. And yet, uh, Coinbase did not lose. The SEC came back, said, well, we need a little more time. And, and the, uh, and the third third circuit said, okay, we'll give you more time. And so the SEC has to report back. I think it's in October. Um, on where they are. So that maneuver was, I think, very helpful as a first shot. Then the complaint came in, and so Coinbase's response was to alert the judge that they were going to file a motion to dismiss under Rule 12c. Now, this is a little bit different, a little bit out of the ordinary.

Usually, you file a motion to dismiss under 12B. And so under 12C, it's not a motion to dismiss. it's a motion for judgment on the pleadings. And this is a little, you know, technical, legal stuff. But the main difference is on a 12 motion to dismiss, the court looks at the complaint. It says, okay, if everything in here is true, have they stated a claim? Or is there nothing there? That's generally the approach you take. Under 12C, the court reads all the pleadings. So the complaint and the answer. And so there's more in front of, of the judge, and usually there's some other documents and filings and things the court can take judicial notice of, not just mere allegations, but other things, SEC filings, the court can take

judicial notice of, the S-1, those kinds of things. And then the court can make a ruling on the pleadings under 12C, and so that's what the Coinbase has asked the judge to do. So the next step after saying, hey, we're going to file a 12C motion is to file an answer. And they didn't file your run-of-the-mill answer. So usually in an answer, you list all of the allegations from the complaint in numbered paragraphs. And then under them, you say, admit. Denied, denied, denied, denied. Usually it's denied, deny, deny, or, you know, there are different flavors of answer. But this was, they went above and beyond. Again, because they're filing a 12C motion. They want to put more in front of the judge. So they took the opportunity to tell their story. It's really an

interesting document. Before they get into paragraph by paragraph admit or deny, they tell their story. It's not a brief, so it's not a bunch of citations with arguments. It's really telling their story and introducing the judge to the framing of the case. And there's just usually not an opportunity for a defendant to do this, but they've created this opportunity for themselves. So they spend a lot and there's no limit, page limit or anything like there is with a brief. So they went into detail and they attacked it from every angle and they put, they put everything in there, again, because it will color this, this expedited review that they want. So, so that's their response. So then, so where are we now? I'll just, I'll just, uh, yeah.

kind of finish the story. So they have to ask permission from the court to file this motion under 12C. So there was a pre-motion conference in front of the judge last week that was fascinating. Again, nothing about this case is run of the mill. But anyway, in terms of posture, the court will rule on whether or not Coinbase can file this motion. and when they know to continue waiting sorry to let yeah that

that was stream they sorry the court will if the court approves the filing of the motion the court will set a briefing schedule so then we'll see one of the briefs coming on the 12C

motion and when might it be argued so that's what we're waiting for now after the hearing last week but everybody's still reacting to what happened in that hearing last week. Perfect. No, this is great background. I just want to jump into a couple of specific things that both the SEC alleges and Coinbase kind of denies or alleges because, again, we've only got about an hour.

And these are very long complaints. So I don't think we'll be able to hit everything, but I want to make sure we hit the top stuff. The first thing I want to talk about is one of Coinbase's biggest defenses is, hey, even if the SEC has the authority to do this, they should not. be doing this. We can get off on this because of the regulatory. I believe the quote is the regulatory uncertainty that the SEC created, right? And Coinbase points to two really specific facts here. One, the SEC let us IPO, right? In 2000 or 2021, we filed an S1 and the SEC approved the S1. And number two, for years, the SEC has said, we can't regulate crypto. We don't have the authority. They have direct quotes from the former SEC Commissioner. I think that was Jay Clayton and the current

SEC commissioner, both when he was an academic and when he was at the SEC saying, we can't regulate the crypto. And then obviously he changed his mind 12, 18 months ago, whatever, and he's trying to regulate crypto. So Coinbase is coming saying, hey, even if you think the SEC has this, like this is completely unfair to us because it's an abusive process because of all this regulatory inserts, they talked about. How do you think about that defense? Well, there's actually two different arguments baked in there. Yep. So the first argument that Coinbase makes, it has a lot of appeal just from common sense, which is if they thought that there was any basis for us to need to register as a securities exchange, they should

have at least mentioned it. They've had every opportunity. And the story really hangs together. If you read in their answer, it's not only, hey, we went in there and they were really tight-lipped. They didn't say anything. It's their private dealings with Coinbase when they were reviewing the S-1 were entirely consistent with the public statements that Chair Gensler made. When Chair Gensler went in front of Congress and said, we do not have the authority to regulate, these exchanges, that's entirely consistent with what the SEC was saying privately. So that story hangs together just as a matter of common sense. Now, how it plays out legally, we'll see how it shakes out. But just as a matter of common sense, it's a powerful argument that the SEC should not

be able to just decide one day that now they have the authority. Right. And, and, and, and, If, in fact, they were wrong when they were saying they did not have the authority and now they're correct that they do have the authority, then an enforcement action is not the due process fair way to proceed, right? It would be, hey, we'll give you notice. In fact, it turns out, sorry, we do have authority. So work with us and we'll get you registered. And if Coinbase, you know, refuse to register at that point. respond. That's the common sense argument. But there's a there's a legal, a legal doctrine known as the major questions doctrine. And so this is the other argument baked in with these same facts,

which is the SEC was right back then. They don't have this authority. Why? Because Congress hasn't given them that authority. And the fight is well, you know, under Howie, under the securities laws, they've got the authority to regulate securities, and they're just arguing these are run-of-the-mill securities. What new authority do they need? But of course, it's compelling that digital assets don't fit squarely under Howie. And the Ripple decision, of course, has upended all this because it really, really makes the point. Tell the Ripple decision, the SEC has been able to say, hey, we're undefeated. All the courts seem to agree with us. We have this. authority. But now that is no longer the case. Yeah. And I guess we should probably just start

talking Ripple and go there. But I do just want to throw a couple things in. I think to your point on the SEC for years saying you don't need to register as an exchange than saying you do and then coming out at them with an enforcement action instead of working with them, Coinbase described that as an abusive process by the SEC, which I'm completely with you. It is weird if for five years you say, hey, you don't need to register. And then all of a sudden you say you need to register and we're suing you to kill you and fines and everything instead of work. Let's talk Ripple. So the Ripple decision comes out last week or two weeks ago, I can't remember.

And the Ripple decision for Ripple, it's a mixed decision, right? They say, hey, sometimes when you sold securities to correct me if I'm wrong, when you sold them directly to institutional investors, that Ripple was a security there. But when Ripple is publicly traded on a secondary exchange where the buyers can be retail, can be institutional, but they have no expectation of actually working with and funding Ripple. And that case, it's not a security. That's massive for Coinbase because Coinbase is doing a secondary market so they can point to the Ripple decision and say, a court just said a secondary market is in securities.

I'll pause there and say, did I miss anything in my very quick overview of Ripple? Or do you want to go into why this is so important for Coinbase? Well, no, that was a very good summary. I think we're at the one week anniversary of the ruling. And it's very interesting, the takes that have happened in the last week. But just on the ruling itself, yes, it was technically a split decision because the SEC won on the sale of XRP to institutional investors, qualified as investment contract, and really Ripple won on just about everything else, there's one little issue on whether the individuals should be separately liable for the part that the SEC won on against Ripple, and that would theoretically go to trial if it goes in that direction. it was not dispensed with on summary judgment. So yes, technically a split decision.

However, as far as Coinbase is concerned, it is a 100% laydown victory for them. Because the key ruling that everybody's pointing to is that XRP itself as a token is not a security. Yep. And what that means is that where it flows and goes and changes hands, it could or could not be part of an investment contract. But the transfer of XRP by itself is the court ruled is not an investment contract, is not a security transaction. You need more.

And of course, what Coinbase is operating is an exchange where people just sell tokens like XRP. It's now been relisted with nothing more. So it's a monumental decision for Coinbase. Can I just jump in and at? So, you know, it seems strange to me, and as a novice, as a layperson, it seems strange to me that you could rule, hey, if you buy directly from Ripple, that is a security. But if you buy it on the secondary market, and I believe the reason the judge ruled this is because when you buy it on the secondary market, devoid of a relationship with Ripple, you have no expectation of profit or contract with Ripple. I can't remember the exact thing. I'll let you clean up what I'm saying. But, you know, it does seem like an incoherent or slightly of conflicting decision there because if I go buy a stock, everyone agrees is security, right? When I go buy a stock on the secondary market, I'm not buying it directly from GE or IBM. Many of these companies haven't issued equities in years, but it is still a security because I am

I am relying on an expectation of profit from the company to drive my profits there, right? With Ripple, yes, I understand maybe it's not stock, though I think a lot of these were kind of set up to be stock, but you're relying on an expectation of profit or benefit from the ripple ecosystem to benefit from it. It just seems like a very strange decision. Maybe you can clean up what I was saying and give me your take on it. Well, let me put my finger right on it. The coherence and the strangeness of the outcome, I think it's apparent that comes not because the decision is wrong, but because of how Howie applies to digital assets. This is what the industry has been saying since the very beginning. This is the wrong test to apply to digital assets because they're new

and different and they don't act like anything else. It's the SEC saying, no, no, no, Howie is perfectly flexible enough to encompass anything. And what we see, this is strange because, yeah, if you apply Howie to XRP being sold to institutional investors, it comes out one way. If you apply it being sold on the secondary market through blind, blind buy, sell, it comes out a different way. That's not because the judge was getting it wrong. The analysis is fairly straightforward. It's because the Howie prongs applied to a token that has no legal rights, no equity rights, no income rights, no rights whatsoever. Applying it to that, it's going to come out this way.

It's, it's, it's, it's, so anyway, I think that actually is why it seems odd. I read probably the same article you read. It sounds very familiar of, hey, you know, this is backward. The institutional investors actually need less protection than the secondary market, uh, investors, but that may be the case, but it's not, it's not because how he applies to XRP as a token. So this would go back to one of Coinbase's many defenses, and this is the one they were making, I don't believe they put this into their response, but they did put this into the public

domain. And I think there is something here, right? Hey, every other jurisdiction, we don't have this problem because we have one regulator for securities and commodities. We only have this problem in the U.S. because, you know, if you regulate securities and commodities, well, clearly crypto is one of the two. So if you've got one regulator, you can work with them on all of them. Here we've got the commodities commission and the SEC because maybe crypto flows back and forth between the two, depending on if it's primary, secondary, what the uses are. The issue is there's this vague area. And that's kind of where the ripple decision is showing the issues. Am I thinking about that correctly? I think you're absolutely thinking about that correctly. And what that leads to is

the new legislation being proposed in Congress. Congress is thinking about it the right way, in many cases, they propose many different bills to address crypto. But a lot of them say, look, we're going to define certain digital assets as restricted, as secure. but they need to have more than just your run-of-the-mill token that has nothing associated with it. And everything else is a commodity. And we will put those under the regulation of the CFTC and the SEC. And now a quick word from our sponsor. Today's podcast is sponsored by Stream. I've been looking deeply at the SEC's litigation against Coinbase. And Stream was kind enough to introduce me to a crypto lawyer to have this conversation with and to dive deeply

into the themes and topics and the suits. If you like this conversation, you can find many more like it by checking out Stream's expert call library. Please see the link in the show notes. This goes back to the major questions doctrine a little bit, but Coinbase's response, a lot of it does talk about, hey, there are many people in Congress who have introduced bills to proper, as you're saying, to kind of properly regulate crypto. None of them have passed.

Maybe none of them do pass. Maybe none of them don't. Obviously, if one of them passed, that would be huge for Coinbase because then they could point to that and say, hey, we can dismiss this complaint. We have regulation. But I think in the legal court, the argument they're making is, hey, you know, Congress knows there's an issue. They're working on it. They're trying to, they're trying to get proper regulations here. Even if they don't, this kind of shows the SEC is overstepping their bounds. Is as a legal argument? Is there any anything to that? Is there any precedent where, hey, Congress is trying to introduce legislation to

this? So the SEC doesn't have a right to regulate this? Yes. There's precedent for this. So this goes back to the major questions doctrine. And the, if the SEC, the theory, the argument, sorry, the argument from point of basis is, if the SEC had all the authority they needed to regulate digital assets in this way, then there would be no reason for Congress to pass comprehensive crypto legislation. And so it's not, it's not dispositive, but it's evidence that this is a major question that Congress has not spoken on yet. So I totally get that, but isn't there just the fact that there's been legislation introduced, isn't that problematic from a legal point of view?

Because I could imagine, you know, I'm from a suburb of New Orleans, right? I could imagine the representative in a suburb of New Orleans if they had one big industry there, they could go and they could introduce a piece of legislation into Congress for their big industry. to raise a major questions issue. And even if they're the only person who's introducing it and there's no support, then the company could always come out and say against the regulator, hey, there's legislation that's been introduced to clarify the regulation here. Major questions doctrine issue, right?

Yes. So that's why it's evidence, but it's not dispositive. And courts are well equipped to say, well, look, one representative introduced one bill. I hear you. I made it to a vote. But we're talking about bipartisan, bills being introduced in successive Congresses, multiple different, so that's better evidence that this. And then you put the ripple decision on top of that, right? Hey, now a court has found

that sometimes it's a security and sometimes it's not. The token itself is not. So the SEC's theory that, no, just all these tokens are securities inherently in and of themselves. their securities when they're traded on the secondary market, that theory is crushed now by the Ripple decision. So adding these pieces of evidence together, right, the congressional legislation plus the Ripple decision, plus other pieces of evidence, that's what you would put forth to a court and say, this is a major question. And the SEC doesn't have the authority yet to regulate it. Let me ask one more question. On the coin-based defense side, one of the pieces they've said is, the SEC approved our S1 and let us IPO.

And I do understand something to the SEC, let us IPO. They didn't say, hey, you can never go public. Your business is illegal. But I think there's also, I shared a screenshot of their S1, like the front page of an of an S1, and this is a direct quote, if I'm reading it correctly, neither the SEC nor any other regulatory body has approved or disapproved of these securities or past representation upon the accuracy of the prospectus. like is there real defense to hey the SEC let us IPO or it does seem to me like it's on the front page of a perspective that SEC is not blessing this is not blessing this business I mean you could IPO a business that's illegal in the United States if it operates internationally right I can't think of any of the off top of my head but cannabis you could IPO a US cannabis business a cannabis business that sells cannabis in Canada because it's not illegal in Canada and you could have a US listing so the SEC isn't blessing that.

Right. This is such a fascinating argument. It's really the first time that I've seen this kind of issue come up of the so-called S-1 defense. Okay. So the SEC definitely has an argument here. However, I told you that hearing was pretty explosive last week. The judge was asking questions and pretty explicitly aligned herself with Coinbase. Again, it's early. This is nothing dispositive. She hasn't made any rulings. but if you go look at the transcript or look at the reporting, she was pressing the SEC on this theory. And she was coming at from a viewpoint of, you know, I get what you're saying about technically whatever, but doesn't Coinbase have a point that, look, you reviewed the S1 for six months. You didn't mention to them that they should probably get registered? You didn't look.

And so Coinbase has come back and said, part of this review, process is to make sure the disclosures are clear and full. That six-month review process, what the SEC does is say, hey, your business is doing XYZ. You need to have a disclosure about that so that when people are buying your stock, they understand that. So I think the way the argument will go is not that the SEC should have said you can't file the S-1 because you're running an illegal exchange, how could you let us publish this S1 without a disclosure that our exchange needs to be registered? But isn't there, isn't one of Coinbase's risk factors that, hey, there's no, I can't remember it exactly. I'll try and pull it up as I speak, but one of the risk factors has

always been, hey, we operate in regulatory uncertainty, we might be required to register as an exchange. Isn't that in the risk factor? So couldn't the SEC point to that? They, yes, but that's different. And I think the risk factor is on whether any particular digital asset is a security. And I think the risk is that the SEC will come in and make them delist it. I think that's how they would frame that. But what they pointed to, I think this is in their answer, is on the cannabis, they found an S1 for a cannabis company and the SEC had required that company to list a disclosure that said sales of cannabis in the U.S. are prohibited under federal law. Okay.

And so that's why I think the argument is going to, why wouldn't you require us to put a disclosure of operating this exchange violates the securities laws? It's an interesting question. That's, okay. So we've talked a lot about, I think we've actually, again, the Coinbase's complaint is long and explosive, I would say. I'm obviously not a lawyer, but I have read several complaints and responses. I've never seen something come out quite this aggressive.

Let me switch to some of the things that the SEC is alleging. You know, so I think the two allegations that really jump out to me are, A, the 12 tokens that they chose to accuse of being securities, and B, the staking program, we can talk about anything else. Again, I'm a layperson, so I could be missing a really damning thing or really thing. But anything that jumped out to you in the SEC complaint as, oh, Coinbase really needs to worry about this? No.

And I would contrast it with the Binance complaint where that came out the day before the Coinbase complaint. And the Binance complaint is rife with damning allegations of internal emails, saying we need to get around compliance. We need to avoid bad stuff that you would not, you know, if you're Binance, you don't want to see that stuff in the complaint. That's a different kind of complaint than what Coinbase got, which is highly technical. Since you mentioned, I mean, the Binance Complaint is full with all sorts of things. I mean, the SEC, certainly they were thinking of their marketing when they filed Binance one day and then Coinbase the next. I mean, it's it's rife with fraud. I don't want to use the term fraud lightly, but it is rife with a lot of issues.

But one thing that jumps out to me about the Binance complaint is the SEC has a hot dock in there where they say, you know, I think it's the CFO of buying and saying, bro, we're running an unlicensed exchange in the U.S. Forget about everything else. Like, that's the worry, right? Binance thought they were licensing and unlicensed exchange in the U.S. Why wouldn't, why did they think that in Coinbase thinks they're not? Well, sorry, as an attorney, what I'm going to say is that's an allegation. I am saying. Thank you for correct to me.

I'll let everything I said was the SEC's allegation, though. Well, when Binance admits it in court, it's tough in their documents. We assume that email exists and we don't know how Binance will defend it. I would not. So again, this is very lawyerly. I would not jump to Binance is going to have to concede internally they believe they were running this. There's all kinds of crazy explanations that come for bad things. So I highly doubt they will concede it. And well, again, we don't want to just focus on Binance. We want to stick with Coinbase. But the SEC has their own problems in the Binance case. Even a lot of the stuff that they have problems with with Coinbase will also apply in the the Binance case. And the Binance case may look worse in the complaint, but Binance will have some defenses as well. So bad emails are not. I mean, just even the fact that, you know, somebody at Binance thought maybe it was they needed to register. I'm sure they'll put up 10 other witnesses saying, well, we didn't register because all these 10 people said, no, no, no, we don't.

And we'll just say, look, that's the confusion. Nobody is on notice of what needs to be done or not. And that, you know, that goes to major questions. That goes to fair notice. So they'll defend it. The staking program that SEC talks about. To me, again, as a layperson, that seemed particularly problematic to me. Can you talk about why the, and Coinbase, they talked about it, but they really focused more

on the other issues with when they were responding to Coinbase. Can you talk to me why you don't think the staking program is an issue for Coinbase? Well, what I'll say is... Oh, do you want to define what, quickly define what staking is for people who might not be super familiar with crypto? Sure. So there's two main consensus protocols for any blockchain, proof of work and proof of stake. And proof of work is what you hear about with Bitcoin, all the energy intensive processes. Proof of stake is an alternative to that, and it's supposed to be less energy intensive because it doesn't require a bunch of miners running at top speed all the time. Instead, staking requires users on the protocol to lock up.

That's all staking is, is locking up some of your tokens, and the more you lock up, sorry, the lockup process goes through a consensus protocol to confirm the transactions on the blockchain. That's the kind of the shortest version of it. But the key here for the case is when you lock up some of your tokens in exchange, for locking them up and not being able to trade them or use them, you get a reward and it's usually paid back in that same token. So the SEC's theory is that that Coinbase was doing the work of staking for the customers and then the customers would get a profit, a part of the reward

for the work that Coinbase was doing. That's the staking theory. So what would happen is, let's say I owned a hundred-eath, right? I could go and I could stake it myself, but that requires a lot of technical knowledge and that personally I don't have. I can barely operate a Zoom sometimes, right? So I could stick it myself and maybe if I stake a hundred-eath, I would get one new a month as my staking rewards, just to make the math really easy. In contrast, I could go to Coinbase and I could give them my hundred-eath, and they will

go manage the staking for me. And I believe what they would do is they'd manage the staking for me, and they would keep, I think it was 35% of the staking reward. So in this case, if I did 100th and I got 1eath, they would keep 0.35th and they would give me the 0.65th. And that would be, that would be my staking. And am I thinking about that correct? Kind of correctly. That's right. So the SEC is out alleging, hey, that right there fails Howie, right? Because you now have, you now have a contract. Coinbase is managing it. I am giving them my eth and I have an expectation of profit, which is huge for the Howie test. Coinbase has failed that.

right there. So what do you think about that allegation? Well, so again, all we have right now is howie. And so what Coinbase has said is this doesn't meet the prongs for Howie. And so the first prong of Howie is an investment of money. And so what Coinbase has said is there's no investment of money here. The staked eth does not go from the customer to Coinbase, right? Coinbase never takes custody of the staked heath. So that is not, you can't count that as an investment of money. And what they say is that point three, the fee that Coinbase takes for the staking, that's not an investment of money. That's a fee for administrative services for helping you do your staking. So they're assisting you with staking. They're not doing it for you. So that's on the

investment of money prong. There's a, there's another kind of. corollary with Howie of whether you're, and it's really on the investment of money prompt, whether you have a risk of loss. So there's some case law that if your money that you're investing and you're trying to determine, well, was it really an investment of money? If there's no risk of loss, then you haven't actually invested any money. There's some case law on that. And that's what Coinbase is arguing here. You put up your Eith and it's stakes. And whenever you want to take it out, you take it out. You can't lose any of that money. So I guess even if ETH went from 2000 to zero, you would still have 100 ETH. It was worth $200,000 before and now it's worth zero, but you still

have 100th. You've never lost ETH in this program. Right. Yeah. And of course, that risk of loss is not from some management thing that Coinbase did. That's just from the ETH market. And that that shouldn't bear on the question of whether you've invested money with Coinbase. So I think it'll be an interesting question. I think a lot of people are surprised that the SEC thinks staking is security. It seems like something different, and it's certainly a sideshow in this case. So I would say it's not the existential threat that whether Coinbase has to register as a securities exchange is. Yeah, so I guess if they are found guilty of that, there will be a fine. They'll have to shut down the staking program, but I doubt they're going to have the whole business shut down over having offered a stake. Though, I mean, if you were staking some of these coins that got rugged pulled and couldn't, if the SEC wins on this, couldn't the argument be the coin base needs to make anyone whole who was staking coins that got rug pulled, then there'd be huge liabilities there?

That's a good question. That's why it's so interesting. Usually the SEC. is bringing enforcement actions against the issuers of tokens for an unregistered security. So Coinbase is not the issuer, and their defense, of course, would be, well, if there was a, if somebody lost something because of a rug pull, you need to go to the issuer who pulled the rug to be made whole for that. And I don't think this complaint actually would cover that situation, but you make a good point. If the SEC wins on this as a security, then they might look around and say, hey, did some people get rug pulled? And so what should we do now? To me, I am with you. I don't think this is like, like the SEC is going for something that really cuts the head off

Coinbase. I don't think this is the thing that does it. But to me, it just seemed pretty obvious a staking program was as security. Because I think about like a stock lending program that you would have at any brokerage. And this looks basically identical to that. It's just hard for me to imagine. There's a contract. I understand the expectation of profit and return is not in dollars, but obviously, people are going to be selling this and expecting their ETH to be worth something. It just seems to me that was a pretty strong argument from the SEC. It's, well, I go back to is how we even the right test for these kind of crypto, staking crypto assets, these kinds of things, we can analogize them to stock and stock lending and

stock trading, but they're not like stocks in so many important ways that it would be better if we were analyzing them under a crypto specific legal regime and legal test. I think Howie is very flexible. It's been a fantastic standard. And yet it's now run up against something where it's kind of a square peg with a round hole. The SEC brought out 12 different tokens that they're accusing of being securities and their complaint against Coinbase. And as you said, Coinbase has another 200. So there is the question of, hey, if they lose on these 12, can they just delist, maybe pay some fines for these 12, but keep the other 200? Or is the SEC going to add another 10 and then another 10 and eventually get them all?

Were there any of the tokens that jumped out to you as particularly likely to be a security? Well, what I would say, I can answer that question, but I'm not sure that's the right question. And Coinbase would say it's not the right question. Okay. Because even if Solana, Cardano, Flow, some of the ones that are named, even if they were securities when the issuer sold them, Coinbase would say that does not mean their securities when they're traded on the secondary market. And so Coinbase is say, we get two bites at this apple.

Yeah. First, we're going to try to tell the judge it was not a security when it was sold. If we lose there, the fallback argument is, well, even if it was, it's not a security when it's sold on the secondary market. And there are additional defenses and arguments for why that would be the case. So look, after Ripple and after my background and my work, I'm not sure that any of these are securities when they were sold. It's possible. Some of them had ICOs. ICOs really look like securities offering.

But the, again, I think the relevant question is when they're traded on Coinbase, are they securities? And right now, I think it's a very difficult argument for the SEC to make. And I like Coinbase's chances a whole lot. Okay. Let me just get a separate. And this just jumped out to me. So you know I'd make a bad lawyer because I'm asking a question off the top of my head that I have no, I don't know the answer to it. But if a token trading on the secondary market is not a security, the basic argument is it's a commodity at that point.

I don't think Coinbase has been particularly, like, heavily regulated by the Commodity Commission or anything like that. And obviously, when I look at some of these securities that proved to be kind of frauds or got rug pulled, would there, would Coinbase have any lingering liabilities from operating an exchange, a commodities exchange without proper regulation or having all of these fraudulent kind of. fraudulent coins that traded and got rug pulled on their exchange there? So operating a spot commodity exchange, there are very few requirements. Again, unlike SEC registration for a securities exchange, a spot commodities market is, unlike a futures market, but just a spot market, it's mainly anti-fraud and anti-mark manipulation. And that doesn't mean that the platform is warranting that there will not be a roadpool. It's that they have certain obligations to make sure the trading is fair, not fraudulent.

And from what they come back with in their complaint, I'm sorry, in the answer, Coinbase has said they're fully complying with all their obligations in running a spot commodities market under the CFTC. Last thing from the SEC suit. So one of the things the SEC says is, hey, you guys implemented an internal, an internal howie test to keep securities that were likely to be security, to keep crypto that was likely to be a security off your exchange. And as the crypto bubble got really booming and competition heated up, you guys started allowing a lot of high securities that you deemed high risk to go onto your platform. And I think the SEC think that's a really good argument that, A, they were listing securities because they deemed these things high risk. And B, they thought all these securities could have the Howie test applied to him.

What do you think about that argument? Well, that might be one of their better arguments. The problem is that, so I ran into this as a private attorney because I actually did this howie analysis for many, many tokens for a lot of clients. And the problem you run into is the Howie analysis is on a spectrum. right okay this fact this prong is a little bit there's a lot of evidence that that it is satisfied this one over here there's less evidence so maybe it pushes over here this one's kind of in the middle it's really on a spectrum when you when you're you know it's a multi-prong

balancing test for all of these but the outcome is binary right it's either it is a security or it is not, but the test is not binary. It really lands on a spectrum. And so analyzing the risk, again, this is flashbacks when I was doing this every day is, well, we find that this one is higher risk than this one. But the question is, do they meet the threshold to become a security? So this one is more likely that the SEC believes is security. But look, for these three reasons, we think, it's on the binary choice, it's not a security. So there's plenty of defenses there. And again, based on what Coinbase has said, they have robust internal processes of review. And they will have plenty of documentation and sourcing for, hey, we felt comfortable that this did not

trip over into becoming a security. And so we decided to list it. Perfect. I think we're almost at the end of our hour. So I just want to ask two final questions. First, a question just timing. You know, Ripple, I think the SEC sued in 2020, and we just got a decision last week, so two and a half to three years. What do you think the timing of, I don't think there's, you can tell me if I'm wrong, I don't think there's a settlement to be reached here. The SEC is saying, hey, we want to kill your business and Coinbase is saying, hey, you don't have a right to and we try to regulate. Like, there's just, that doesn't tend to be the thing you can settle. So if we're going to go all the way to trial, get a judge's ruling everything, what do you think the timing looks like on all that? If we go to trial, it'll, I think it'll be like Ripple.

I mean, it'll be a heavy, heavy discovery, although there are some different calculations here than there were with Ripple. Coinbase has signaled they want this done as soon as possible. And Ripple did a lot of the heavy lifting in terms of pulling back the sheet on discovery at the SEC, putting the SEC on trial. And so Coinbase may try to replicate some of that, but not much of that got into the summary judgment decision from Judge Torres. Anyway, Coinbase has signaled it wants this done as soon as possible. So probably it will go a little bit faster than Ripple since there's an interest from the defendant in making it go faster. And you have some control over how long discovery goes. Yep. The other thing here is next year will be electing a new president, and that

change could change everything very dramatically so that if the judgment on the pleadings doesn't go Coinbase's way, they might want to drag it out to see, hey, are we going to get some new leadership for the SEC that could change the calculus here? I was wondering if tactically Coinbase might, because you mentioned having two bites out Apple's in terms of is it a security and, oh, yeah, by the way, we're trading secondary exchange. I was wondering if Coinbase might want a third bite at the Apple of, hey, let's try and get this trial after November 2004 because, as you said, if we have a Republican administration come in, come in, there's going to be a new SEC commissioner.

Maybe a Republican's going to appoint a complete crypto skeptic. Maybe they're going to employ it, but you might as well see if you get a new person at the top because, you know, if you have a new FTC commissioner, then they're going to drop all the Microsoft's Activision type cases, if it's a report. So you might as well see if you get a shot. This has been fantastic. I've really enjoyed this. I think you've done a great job covering everything. I just want to ask, I understand, again, 100 page complaint, 400 page response or whatever it was. There's a lot. But I don't think we didn't talk about that you think listeners should kind of be thinking about either on what the SEC is alleging, what coins defending, or you think we did a good job of

kind of hitting the main bullet points. Well, I think what I would leave you with is, Everyone has seen the impact of the Ripple decision. Yep. So it's really changed the trajectory of things. And it's been a sea change in terms of projects feeling like, hey, there's some certainty here to be had. The SEC can be beat. It's changing the calculus in Congress. There are a lot of good reasons to think Coinbase can prevail.

And that would likewise have a ripple-sized impact, if not bigger, on the crypto community. So I think people should keep their eyes on this. This is every bit the case to watch, just like everybody was watching Ripple and waiting and waiting, waiting for that decision to come out. And because this timeline might be expedited for the Rule 12C motion, we might have, you know, a lot. lot to talk about before the end of the year or maybe early, early next year, depending on how quickly this thing gets briefed and argued. So, yeah, this is a really, really major case. It's going to impact really every corner of the crypto industry so people ought to keep their

eyes on it. It's been absolutely fascinating to watch for a distance. But anyway, Daniel, I really appreciate you hopping on. This has been absolutely fantastic. And looking forward to catching up in the future. All right. Thanks a lot, Andrew. Good talking with you, man.

A quick disclaimer. Nothing on this podcast should be considered an investment advice. Guests or the host may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial advisor. Thanks.