Crypto faces legal judgment as SEC prepares action against Coinbase

Coinbase has taken an increasingly defiant stance, publicly criticizing the SEC and urging regulators to write new rules for crypto rather than enforce existing ones. Complying with the SEC, according to the company, would effectively mean closing its operations.

“The implications for the crypto industry are very significant,” said Neel Maitra, partner at Wilson Sonsini Goodrich & Rosati, who previously worked at the SEC as a crypto specialist. “Much will depend on the precise form that potential SEC action takes.”

Regulators have come under increasing pressure to crack down on crypto since the collapse of FTX, whose founder Sam Bankman-Fried aggressively lobbied policymakers last year. Pro-crypto lawmakers criticized the SEC for not spotting FTX’s problems before it exploded, though some also criticized the agency’s investigations early last year. .

Since 2021, Gensler has warned platforms such as Coinbase that they are breaking the law by allowing investors to trade cryptocurrencies that should have been registered as securities, the legal category that includes stocks and bonds. . He demanded that companies comply with SEC rules by registering as stock exchanges and segregating parts of their business that create potential conflicts of interest.

Now the SEC is preparing to test Mr. Gensler’s views in court. While a trial could still be months away — or avoided entirely — the formal process that began this week could potentially end with a court ruling ordering Coinbase to shut down or restructure significant parts of its business in the United States. UNITED STATES.

SEC staff say it could seek remedies including injunctions, cease-and-desist orders and fines, penalties that could threaten the company’s ability to operate in its current form. If it registered as a stock exchange, as Gensler requested, Coinbase would only be able to list SEC-registered securities. Yet, no major cryptocurrencies – or any of the 242 assets currently listed on Coinbase – are currently registered with the agency.

Chief Legal Officer Paul Grewal said Wednesday that Coinbase representatives had met with the SEC more than 30 times in nine months and spent millions of dollars working on proposals to register parts of its business. That process appeared to end when the SEC canceled a meeting with Coinbase in January and moved on to enforcement, he said.

After disclosing the Wells notice — the term for the letter a regulator sends to inform a defendant of the charges it intends to file — on Wednesday, Coinbase executives expressed disappointment but said they were preparing for litigation.

“We are very, very confident that we will be able to defend these claims, not just for Coinbase but for crypto as a whole,” Grewal said Thursday.

The company has accused the SEC of stifling innovation and has spent millions of dollars lobbying Congress in hopes of circumventing regulators through new legislation. It has also stepped up its political organizing, seeking to rally its users to write to lawmakers and donate to pro-crypto candidates.

The crypto industry increasingly sees Congress as its best hope to continue business as usual in the United States, where most financial investments that depend on third-party efforts are covered by SEC regulations. . Gensler said the vast majority of crypto tokens, with the exception of bitcoin and perhaps a limited number of others, are securities.

Fighting the SEC could be costly at a time when Coinbase’s business is already under pressure from a downturn in crypto markets. Ripple Labs Inc., a crypto company defending against an SEC lawsuit filed in late 2020, expects to rack up $200 million in legal fees before the case is decided, according to people familiar with the matter. case.

The first cryptocurrency, bitcoin, was designed to be a peer-to-peer payment system. But so-called centralized exchanges – platforms operated by companies such as Coinbase, Binance and the now defunct FTX – have become the backbone of the crypto industry. Using a combination of bank accounts and blockchain addresses, they serve as primary access points for individual investors to exchange dollars for cryptocurrencies, or vice versa. That’s why Mr. Gensler shifted the SEC’s attention to these intermediaries shortly after taking the reins.

“What we focus on in crypto is compliance,” Gensler told reporters on March 15, adding that investors should have the same protections in crypto that they have on the market. stock market. “Each of these token operators and intermediaries, in consultation with their advisors, know full well what it means to have full, fair and truthful disclosure.”

To date, the SEC’s crypto enforcement actions have been more progressive. He has filed dozens of lawsuits against individual token issuers for offering unregistered securities. Over the past year or so, it has sued or settled with several crypto lenders, and in February the SEC settled with Coinbase rival Kraken over the company’s so-called staking product.

“The average American who buys or sells cryptocurrencies tends to do so through Coinbase,” said Kristin Smith, head of the Blockchain Association, a trade group of which Coinbase is not a member. “That’s the biggest target the SEC could aim for.”

The SEC advisory comes as disparate parts of the federal government – ​​from the White House to the Federal Reserve – have reported growing skepticism towards crypto as an asset class after the sudden collapse of FTX in November.

On Tuesday, President Biden’s annual economic report to Congress included a 35-page section focused heavily on the risks of crypto to investors and the industry’s failure to comply with regulations. “Crypto-assets currently do not offer widespread economic benefits,” the report states. “These are largely speculative investment vehicles.”

Write to Paul Kiernan at [email protected]