LCX Benefits On SEC Ruling 9 Crypto Assets Are Securities While Other Exchanges May Delist Tokens

Much of the cryptocurrency world is anticipating continued fallout over the U.S. Securities and Exchange Commission’s allegations in a civil lawsuit that nine crypto assets involved in an insider trading case are securities. The designation comes as the regulator is reported to be investigating whether the largest American crypto exchange, San Francisco-based Coinbase offered unregistered securities. Hundreds of other exchanges around the world are trading the nine assets named in the insider trading case, forcing a tough decision: ignore the allegations and wait for an official ruling or pre-emptively appease the SEC and stop listing the assets now to avoid a Coinbase-style action.

With more than 100 exchanges globally trading at least one of the nine tokens named in the SEC complaint, according to CoinMarketCap.com data, the fallout could be widespread. Among the exchanges are centralized giants like Coinbase, Binance in the Cayman Islands and Seychelles-based KuCoin. Decentralized platforms like Uniswap, which also list some of the tokens, are much easier for investors and developers building their own trading services to access and could prove more difficult to regulate.

Jason Gottlieb, a partner at New York law firm Morrison Cohen, known for its crypto litigation tracker, says that while much of the focus since the insider-trading suit was filed has been on Coinbase, the “knock-on effects” will go far beyond the public exchange with a $12 billion market capitalization. How other exchanges respond could impact not only the wealth of current owners, but the very process by which new assets in the nearly $1 trillion crypto market are created and traded.

“Exchanges have to consider carefully whether they want to continue to list these tokens, now that the SEC has declared, at least its view, that the tokens are securities,” Gottlieb says. “But there’s obviously a pretty heavy gravitational pull towards doing what the SEC wants you to do, so that you stay out of trouble with the SEC. I imagine that at least the U.S. exchanges will have to think carefully about whether to be listing these tokens.”

Coinbase in particular has spoken out against the SEC’s action. Paul Grewal, chief legal officer at the exchange, posted a Twitter thread early this week stating that the company disagrees with the SEC action and accused the agency of regulation by enforcement. “We are confident that our rigorous diligence process — a process the SEC has already reviewed — keeps securities off our platform, and we look forward to engaging with the SEC on the matter,” Grewal said in a statement provided to Forbes. New York-based Gemini, which also trades some of the assets, declined to comment. Binance, Kraken, KuCoin and Uniswap did not respond in time to requests for comment.

The first domino fell last week, when the SEC demanded a trial by jury for its complaint against former Coinbase employee Ishan Wahi, who the regulator accuses of leaking information about when tokens would be listed on the exchange to his brother Nikhil and a friend, Sameer Ramani. The SEC alleges the recipients of the insider information purchased Amp (AMP), Rally (RLY), DerivaDao (DDX), XYO (XYO), Rari (RGT), LCX (LCX), Powerledger (POWR), DFX Finance (DFX), and Kromatika (KROM) tokens ahead of their Coinbase listings, selling them to collect more than $1 million in profits. The Wahi brothers’ attorneys denied the SEC claims in statements provided to Reuters.

The SEC’s jurisdiction over the case relies on the nine tokens listed passing the Howey Test, established after a U.S. Supreme Court case outlined what constitutes an investment contract. According to the test, an investment contract exists if there is money contributed to a common enterprise with a reasonable expectation of profits from the efforts of others. In the insider-trading filing, the SEC outlines how the nine tokens fulfill these requirements. Interestingly, every one of the tokens is on the Ethereum (ETH) blockchain.

Typically, tokens see a price jump of 91% following a listing on Coinbase, according to research firm Messari, affording insiders the chance to make millions by buying them in advance, the SEC alleged. Lewis Cohen, a lawyer specializing in blockchain and tokenization for DLx Law, says if the exchanges do not delist the assets, it could be a signal they are ready to go head-to-head with regulators.

“You can understand an exchange saying, look, it’s just not worth it to me to pick a fight with the SEC on this,” says Cohen. “It will be really interesting to see. If we don’t see those assets delisted on other U.S. exchanges, I think that would be a pretty clear sign that the industry is ready to take this up formally.”

Criminal charges by the Department of Justice, which do not depend upon the assets being classified as securities, against the Wahi brothers and Ramani accuse the trio of wire fraud conspiracy and wire fraud. In June, the DOJ filed a similar suit against Nathaniel Chastain, a former employee at non-fungible token (NFT) marketplace OpenSea. Chastain allegedly purchased NFTs he knew through his position were scheduled to appear on the OpenSea homepage, which typically inflates their value. Chastain’s lawyer, David Miller, maintained his innocence in a statement issued to several outlets, “Mr. Chastain is not guilty of the charges. When all the facts are known, we are confident he will be exonerated.”

When the DOJ and SEC both prosecute a case, the SEC action typically does not go to trial while the DOJ case moves forward, according to Gottlieb, who says he isn’t involved with any of the parties involved in the Coinbase actions. “The overwhelming likelihood here is that the SEC case does not get tried,” Gottlieb said. “What you’re left with is the SEC coming out making this big, grand judicial pronouncement of the tokens being securities in a way that the projects themselves don’t have a good way of defending.”

If the SEC case does not go to trial, the companies behind the tokens named in the complaint will likely not have the same opportunity Ripple Labs has had to defend its token XRP. In December 2020, the SEC deemed that cryptocurrency a security and charged the company and two executives with $1.3 billion in unregistered offerings. Shortly after the SEC charges were announced, Ripple filed a motion rejecting the contention that XRP is a security or investment contract. The case is ongoing. In the wake of the allegations, a slew of exchanges delisted XRP, including Coinbase and Kraken. The Coinbase insider-trading case could similarly cause exchanges carrying the nine specified tokens to reconsider their listings.

“It always befits companies in this space to re-examine what they’re doing to make sure they are staying compliant with whatever the SEC’s latest interpretation or pronouncement, or litigation activity reflects,” Gottlieb said. “To the extent there is information to be gleaned from the SEC’s allegations in this Coinbase insider-trading case, it makes sense for companies to re-examine their protocols and procedures to see if there is something they can be doing better to be in compliance with the SEC’s views of what the securities laws require.”

What happens now? Gottlieb says that the “legally obliged” next step is for the insider-trading defendants to file a motion to dismiss or an answer to the SEC. “But, in a case like this, where there are parallel criminal charges, it’s unclear that there will ever be much of a next step in the case. I would say that the next most likely step is a motion to stay. Because otherwise, they will have to put statements into the record that could be used against them in a criminal case.”