The US government is prosecuting its first ever insider trading case involving cryptocurrencies, against a former employee of the crypto exchange Coinbase and two people he allegedly tipped off.
Though the alleged scheme may have been an isolated incident, the ramifications could be much more widespread.
In addition to criminal charges brought by the US Department of Justice (DOJ) in federal court in Manhattan, the US Securities and Exchange Commission (SEC) brought civil charges for securities fraud in federal court in Seattle.
While the SEC is ostensibly going after a rogue Coinbase employee, it is also asking a federal judge to weigh in on whether nine cryptocurrencies tied to the allegations are, in fact, unregistered securities. If the judge accepts the SEC’s premise, it could open up additional liability both for the cryptocurrencies in question and the platforms that facilitate their trading.
The Coinbase insider trading scheme
The SEC charged former Coinbase manager Ishan Wahi, his brother Nikhil Wahi, and his friend Sameer Ramani with violating the anti-fraud provisions of federal securities laws, while the DOJ brought criminal wire fraud and conspiracy charges against the trio.
According to the government’s allegations, Wahi had advanced knowledge of which cryptocurrencies were about to be listed on the Coinbase platform and shared that information with his brother and friend so they could buy the coins ahead of the listings. The complaints allege that Nikhil Wahi and Ramani made more than $1.1 million on trades with nonpublic information.
The cryptocurrencies in question are:
- Amp (AMP),
- Rally (RLY),
- DerivaDAO (DDX),
- XYO (XYO),
- Rari Governance Token (RGT),
- LCX (LCX),
- Power Ledger (POWR),
- DFX Finance (DFX), and
- Kromatika (KROM).
The DOJ is suing for insider trading through federal wire fraud statutes, but the SEC, in order to have a case, needs to go further. “The SEC only has jurisdiction if the assets in question are securities,” Adam Pritchard, a securities law professor at the University of Michigan Law School, told Quartz via email. The complaint alleges that the cryptocurrencies are “investment contracts” under the Howey test, a 1946 US Supreme Court standard.
The SEC press release announcing the charges brought by the agency delved right into the bigger-picture issues raised by its actions.
“We are not concerned with labels, but rather the economic realities of an offering,” SEC enforcement chief Gurbir S. Grewal said in a press release announcing the charges brought by the agency. “In this case, those realities affirm that a number of the crypto assets at issue were securities, and, as alleged, the defendants engaged in typical insider trading ahead of their listing on Coinbase. Rest assured, we’ll continue to ensure a level playing field for investors, regardless of the label placed on the securities involved.”
“A pretty easy case to make”
Tyler Gellasch, executive director of the Healthy Markets Association and a former SEC lawyer, thinks the case is a slam dunk. “These things are very obviously securities that are being traded, and the places that are trading them are also not registered to be doing that,” he said.
A victory for the Commission in this case could open up Coinbase and other intermediaries to legal liability. If a judge rules the coins are securities, “it makes it easier for the SEC to go after Coinbase for being an unregistered securities broker/exchange,” Todd Phillips, the director of financial regulation at the liberal think tank Center for American Progress, noted in a tweet. “If they listed coins that a court has already deemed to be securities, that’s a pretty easy case to make.”
But an SEC win here wouldn’t rule that all cryptocurrencies are securities—just that some or all of the nine in question are.
“The test for whether something is a security is asset-specific,” said Ann Lipton, a corporate and securities law professor at Tulane University School of Law. “Some crypto may be securities, and some may not be, so the SEC doesn’t prove a whole lot by establishing some assets are securities—it still needs to prove it again for the next asset.”
Coinbase fires back at the SEC
In a statement, Coinbase’s top lawyer applauded the DOJ’s efforts to bring its former employee and his associates to justice, but slammed the SEC’s involvement. “We understand that the SEC filed securities fraud charges related to this wrongdoing,” tweeted Coinbase chief legal officer Paul Grewal, a former federal magistrate judge in California. “The DOJ did not charge securities fraud. No assets listed on our platform are securities, and the SEC charges are an unfortunate distraction from today’s appropriate law enforcement action.”
A Coinbase spokesperson pointed Quartz to a statement by Caroline Pham, a commissioner at the Commodity Futures Trading Commission, criticizing the SEC’s litigation. Pham called the suit a “striking example of ‘regulation by enforcement’” and instead called for new administrative rulemaking. Coinbase itself called for similar rulemaking efforts in a blog post today.
The US government signaled in June that it is planning to take crypto enforcement more seriously. That’s when it charged a former employee of OpenSea, the popular nonfungible token (NFT) marketplace, with insider trading through federal wire fraud and money laundering charges. While similar charges were levied against the former Coinbase employee and his alleged co-conspirators, the SEC’s involvement signals that SEC chairman Gary Gensler, who has long criticized cryptocurrencies, is ready to take action.