A US crypto insider trading case may be trouble for Coinbase Quartz

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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, he is also asking a federal judge to weigh in on whether ninecryptocurrencies tied to the allegations are, in fact, unregistered securities. If the judge accepts the SECs 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 SECcharged 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 governments 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), andKromatika (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 Howeytest, 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, well 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, thats a pretty easy case to make.

But an SEC win here wouldnt rule that all cryptocurrencies are securitiesjust 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 doesnt prove a whole lot by establishing some assets are securitiesit still needs to prove it again for the next asset.

Coinbase fires back at the SEC

In a statement, Coinbases top lawyer applauded the DOJs efforts to bring its former employee and his associates to justice, but slammed the SECs 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 todays appropriate law enforcement action.

A Coinbase spokesperson pointed Quartz to a statement by Caroline Pham, a commissioner at the Commodities Futures Trading Commission, criticalizing the SECs litigation. Pham called the following 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. Thats 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 SECs involvement signals that SEC chairman Gary Gensler, who has long criticized cryptocurrencies, is ready to take action.

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