On July 21, 2022, the United States Department of Justice (DOJ) and the United States Securities and Exchange Commission (SEC) each alleged insider trading violations against a former Coinbase employee, his brother, and another of his presumed knowledge. Coinbase is one of the leading exchanges in the United States for trading cryptocurrencies. The DOJ filed wire fraud charges against the three defendants in the Southern District of New York without any allegation of securities law violations, while the SEC filed a civil suit for insider trading in violation of the Section 10(b) of the Securities Exchange Act of 1934 [15 U.S.C. § 78j(b)] and Rule 10b-5 thereunder in the Western District of Washington against the same three defendants.
The SEC’s action raises questions about the state of digital asset regulation in the United States and could hamper the development of digital assets in the United States if there are no changes to this ” Regulation by Enforcement” by the SEC.
The case as presented by the SEC/DOJ and the DOJ indictment:
The factual allegations of the SEC and DOJ cases are largely the same. According to the DOJ indictment and SEC complaint (available here and here), Ishan Wahi (“Ishan”), is a former Coinbase product manager assigned to the asset listing team. In this role, Ishan “was involved in the highly confidential process of listing crypto assets on the Coinbase exchange” DOJ Indictment, ¶2. Coinbase has numerous requirements before allowing a digital asset to be listed for trading, including that it does not list tokens that it considers securities under US federal securities laws. Due to the stringent criteria for listing a digital token on Coinbase, the market price of the token typically increases once there has been a public announcement that the token will be listed. As such, knowing in advance that Coinbase will approve a token’s listing could be used to purchase the token at a potentially unfair discount. Identifier.
Ishan reportedly read Coinbase’s asset listings in advance and told his brother Nikhil Wahi (“Nikhil”) and former college roommate Sameer Ramani (“Sameer”) about these upcoming listings. This allowed Nikhil and Sameer to buy these assets before listings and realize at least $1.5 million in combined gains after these assets had predictable increases in value after being announced to be listed on the one of the largest cryptocurrency exchanges in the world. DOJ Indictment, ¶3.
The scheme appears to have been detected by Coinbase. On May 11, 2022, Coinbase’s Director of Security Operations reached out to Ishan to schedule a meeting regarding an alleged privacy breach that resulted in numerous asset swaps ahead of Coinbase’s listing announcements. This increase in trading was also inferred in the market and discussed on Twitter, largely thanks to the Twitter influencer @Cobie tweet about suspicious business activity. Cobie’s tweet is cited in the DOJ indictment. DOJ Indictment, ¶15.
Perhaps to avoid showing up for the interview with Coinbase’s chief security officer, Ishan bought a one-way plane ticket to India and sent emails to his friends and colleagues explaining that he had to go home for a family problem. DOJ Indictment, ¶18. However, this escape attempt was thwarted when Ishan was apprehended by authorities and prevented from leaving the United States. According to the indictment, when he was apprehended, Ishan had in his possession “a wide range of personal effects, including, among others, three large suitcases, seven electronic devices, two passports, multiple other items of identity, hundreds of dollars in US currency, documents and other personal effects and items DOJ Indictment, ¶20.
While Ishan and Nikhil have been arrested and will face charges of a possible 20-year prison term, Sameer remains at large and is believed to be in India, having left the United States shortly after being informed by Ishan of Coinbase’s internal investigation. Complaint to the SEC, ¶16.
The DOJ accusations alone are certainly newsworthy with similarities to the DOJ allegations against former OpenSea executive Nate Chastain (which we covered on the BitBlog here). Seen in a bubble, the DOJ’s action appears to demonstrate effective compliance, enforcement and collaboration between government, industry leaders and social media activists, as the combined investigative efforts of the three parties led to bringing the perpetrators to justice. Indeed, it is the public nature of the blockchain that has allowed individuals on social networks to uncover these suspicious transactions. Coinbase also cooperated with the DOJ investigation.
The DOJ action shows how fraudsters can be caught under existing laws without expanding securities laws. While the DOJ uses “insider trading” language in its press release, the charges are brought under the federal wire fraud law (18 USC § 1343) for Ishan’s alleged violation of his agreement. with Coinbase and Nikhil/Sameer’s use of such confidential information.
Charges in the SEC Civil Action:
When the DOJ charges defendants with insider trading, it is not uncommon for the SEC to also file a parallel civil action which is usually stayed for the duration of the criminal action. This case is unusual, however, because the DOJ alleged insider trading under traditional wire fraud laws rather than securities laws. Yet the SEC decided to file a civil lawsuit for securities insider trading against the same parties. Since the charges brought by the SEC are not identical and there are major legal issues (such as whether the tokens are securities) that are unlikely to be addressed in the DOJ case, it is unclear if these procedures will remain during the DOJ. pursuit.
Coinbase has repeatedly asserted that none of the coins it lists are securities. For example, in Coinbase’s written testimony for the Congressional Subcommittee on Capital Markets, Securities, and Investment, they stated:
“To assist potential market participants, we have released our Digital Asset Framework to provide transparency on how we plan to list new assets. A key factor in our framework analysis is the determination that the potential new asset is not a security under US law. The lack of regulatory clarity has slowed our willingness and ability to list new assets. (Full written testimony available here).
However, the SEC affirmatively alleged that at least nine of the 25 tokens traded by the defendants prior to their Coinbase listing are “crypto asset securities,” trading of which on nonpublic information violates Section 10 ( b) the law on foreign exchange [15 U.S.C. § 78j(b)] and Rule 10b-5 below. The nine assets deemed to be crypto asset securities by the SEC are $AMP, $RLY, $DDX, $XYO, $RGT, $LCX, $POWR, $DFX, and $KROM. SEC Complaint, ¶¶ 39, 45, 50, 57, 71, 78, and 82. Although neither the SEC nor the DOJ has released the full list of assets traded by Ishan, Nikhil, and Sameer, we know by comparing the DOJ indictment to the SEC’s complaint that $TRIBE, $ALCX, $GALA, and $ENS are all coins traded by the accused but not purported to be securities in the SEC’s complaint DRY.
Following the filing of the SEC complaint, Coinbase continued to state that these tokens are not securities by issuing a statement from their Chief Legal Officer (and former Northern District of California Magistrate Judge) Paul Grewal titled “Coinbase does not does not list the securities. End of story.” (available here). The SEC has not commissioned Coinbase to trade securities, which Coinbase would not be permitted to do without becoming an SEC-registered exchange. The SEC has not charged any of the 9 issuers of tokens it claims are securities of violating securities laws.
Implications and ramifications:
This action was an interesting strategic decision on the part of the SEC. Rather than bringing a lawsuit against Coinbase, a large public company with almost unlimited resources to defend regulatory action, or even the token issuers, the SEC is bringing this lawsuit against three people who face criminal charges, including the ‘one probably won’ doesn’t fight back at all as he is still on the loose. Since these defendants have limited resources and are likely more interested in staying out of jail than being punished by the SEC, they are unlikely to challenge the SEC’s characterization of the tokens as securities. While Coinbase could try to join the case in inter-litigation, they are unlikely to be able to have much influence on the civil action.
Many, including Coinbase, believe that the SEC would fulfill its duty to protect consumers by putting in place a framework for what is and is not considered safe in the digital asset space. On July 21, Coinbase released an additional statement that “calls on the SEC to develop a workable regulatory framework for digital asset securities guided by formal procedures and a public notice-and-comment process, rather than arbitrary enforcement. or guidelines developed behind closed doors”. .” (Full statement available here). Coinbase said the timing of this statement was incidental and that they planned to make this statement even though they were unaware that the SEC would be pursuing a civil suit in the matter.
The SEC’s action here even drew a rare public rebuke from another government regulator. CFTC Commissioner Caroline Pham released a statement on the SEC matter, describing it as “a stark example of regulation by enforcement.” (Full statement available here). Separately, according to Bloomberg, it was disclosed that Coinbase is also under investigation by the SEC over whether it mislisted unregistered securities. Following the XRP action that has been dragging since late 2020 in which the SEC lost a number of important motions, this action could be used to set a “precedent” where there are no significant votes. opposing the theories of the SEC.
The crypto industry needs meaningful regulatory guidance. As these cases indicate, fraud is a real problem, but this particular action does not appear to have a significant deterrent effect, given the DOJ case which does not involve securities allegations. The stated mission of the SEC is to protect investors; maintaining fair, orderly and efficient markets; and facilitate capital formation. This can only be accomplished in the crypto space once the market understands what is or is not security and there is a viable path to compliance.
© Polsinelli PC, Polsinelli LLP in CaliforniaNational Law Review, Volume XII, Number 217
#issues #raised #SECs #action #Coinbase #employee
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