Page 181: A Complete Review of Coinbase’s Legal Documents – Strong Response to SEC Lawsuit, Seeking Dismissal of Case.

Coinbase's legal documents reviewed in response to SEC lawsuit (seeking dismissal).

Coinbase has submitted a response and a motion to dismiss the case to the U.S. Securities and Exchange Commission (SEC) in its lawsuit against the regulator’s allegations of operating an unregistered securities exchange. In this response, Coinbase strongly contends that the SEC’s allegations lack merit and emphasizes its thorough review of its business practices by the SEC before going public. Coinbase’s Chief Legal Officer, Blockingul Grewal, stated that the company never listed securities and that the process they used for token listings was identical to that reviewed by the SEC in early 2021. This response marks Coinbase’s formal response to the legal dispute, signaling a lengthy legal battle to come.

So what exactly did Coinbase say in these two legal documents? How did they argue that the tokens traded on their platform were not securities? This article summarizes the main contents of the two documents.

Coinbase’s Motion to Dismiss

This application was submitted directly to the judge in this case by Coinbase, and the main request was to dismiss the case directly. After briefly introducing the SEC’s core allegations against Coinbase and its four targets: that Coinbase engaged in spot and institutional trading, securities brokerage, wallet custody, and staking services, the document directly addresses the core issue of this case – whether digital assets and staking services should be considered “securities” – in order to continue the debate on whether Coinbase’s conduct meets the allegations. In the document, Coinbase summed it up very succinctly: “They (referring to digital assets and assets) are not securities. Therefore, this case should be dismissed.”

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In terms of specific logical argumentation, Coinbase systematically refutes the SEC’s allegations based on the Howey test (i.e., the case that formed the basis of the Howey test).

First, it points out that according to the definitions of the U.S. Securities Exchange Act and securities law, the term “security” includes “an instrument commonly known as a ‘security’,” one of which is “an investment contract.” This concept was established in the Howey case 77 years ago, where “investment contract” refers to “any contract, arrangement, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” However, transactions on the Coinbase platform and Prime services do not fall into this type of contract, but rather asset sales, where both parties’ obligations are fulfilled when the digital tokens are delivered in exchange for money. Unlike stocks and other securities, there are no statutory or contractual rights (such as dividends) associated with these tokens when they are traded on Coinbase. Any buyer on Coinbase cannot claim any rights beyond the right to acquire the tokens. Without this ongoing contractual relationship, the SEC’s allegations simply fall apart.

Furthermore, regardless of any additional extrinsic expectations Coinbase’s buyers may have regarding the appreciation of token values, this is not a requirement for profits, assets, or operational management. Classic securities can be simple shares, constituting ownership of dividends and residual enterprise value; preferred shares, with interest and liquidation preferences; debt contracts such as bonds, bills, or other debt contracts, providing investors with fixed returns; and investment contracts, in which investors pay funds in exchange for contractual requirements for enterprise earnings. However, there must be statutory rights to the enterprise. Since the transactions on Coinbase do not involve such rights, they do not fall within the securities scope.

Even if the SEC makes a credible claim that the transactions involved here are “investment contracts,” the “substantial issues” principle requires the dismissal of the complaint. Since Congress explicitly recognizes that it has not delegated authority to regulate cryptocurrencies and is actively considering regulatory structures, the SEC lacks power to exercise “clear Congressional authorization” in this trillion-dollar emerging industry.

Similarly, the attacks on wallet and Coinbase’s staking services are unfounded. The SEC failed to charge that tokens available in wallets had key features of investment contracts, and did not recognize wallet functionality as “brokers” under securities laws. For staking functionality, since the facts stated in the complaint indicate that customers staking through Coinbase’s software neither acquire shares of the enterprise through investment funds nor face loss risks through staking their own tokens, and what they receive is administrative rather than management services, there is no investment contract in law.

This application was retweeted by Coinbase’s Chief Legal Officer, Paul Grewal, on Twitter and received a lot of attention on Twitter.

Coinbase’s 177-page response to SEC’s case charges

In this 177-page response document, Coinbase refutes (or admits to some facts) all the terms in the SEC’s complaint and further presents all arguments and evidence why the SEC’s charges are not valid.

Argument 1: Fully reviewed by the SEC when listed on Coinbase in 2021, but the SEC did not object at the time

According to the document, when Coinbase sought to go public in April 2021, the U.S. Securities and Exchange Commission announced that Coinbase’s registration statement was effective, allowing Coinbase’s stock to be sold to millions of retail and institutional investors. This announcement came after “months of discussions with Coinbase and extensive review and comment on Coinbase’s registration statement.” Coinbase opened its business to the SEC, explaining its core businesses such as listing, trading, and staking digital assets, as well as its self-custody wallet software, which is a core aspect of Coinbase’s operations then and now. In light of its mission to consider the “public interest and investor protection,” the SEC allowed Coinbase to go public and never suggested that Coinbase must register its business.

Argument 2: In the 2021 listing review, the SEC never classified digital assets as securities

Coinbase mentioned that this year’s SEC lawsuit accused Coinbase of failing to register as a national securities exchange, broker, and clearing agency since 2019. Based on this accusation, the SEC claimed that 12 of the more than 240 tokens traded on Coinbase’s spot exchange are “securities.” Six of these assets were already trading on Coinbase when the SEC announced the effectiveness of the company’s registration statement. However, in 2021, the SEC did not classify any of them as securities.

Coinbase then said in the filing that the SEC’s change in attitude was not due to any substantive changes in Coinbase’s business since 2021, nor did it mention any changes. Nor was it due to new information. In its complaint, the SEC did not suggest that Coinbase had hidden anything during years of cooperative discussions before becoming a public company. This reversal is also not due to legislative changes. Congress has considered and continues to actively consider multiple regulatory proposals regarding digital assets, but since April 2021, no law passed has given the SEC the power to regulate digital asset exchanges, let alone retroactive rules. The only change in the entire process is the SEC’s position on its authority. Legally, this position is untenable, and asserting this position through such enforcement actions violates due process and the separation of powers principle in the US Constitution.

Argument 3: The SEC may not necessarily have the authority to regulate the cryptocurrency industry, and the lawsuit constitutes excessive regulation

The document mentioned that in May 2021, a few weeks after Coinbase went public, SEC Chairman Gary Gensler testified before Congress that the committee lacked the statutory authority to regulate companies like Coinbase. He said that only Congress could address the regulatory gap that committee officials have long recognized, “because there is no regulatory framework for trading these crypto assets.” He also emphasized that “these crypto exchanges have no market oversight agency.”

Within the SEC’s jurisdiction, the assets traded on Coinbase’s secondary market platform do not fall within the SEC’s jurisdiction, because contrary to the SEC’s assertion, they are not “investment contracts” and therefore not “securities.” Like all securities, an investment contract is defined as an economic arrangement involving a continuing enterprise in which the management has an executory obligation to investors. Without such an obligation, the contract is just an asset sale.

Because Coinbase’s secondary market transactions do not carry such obligations and the value that Coinbase buyers obtain through these transactions is related to the physical goods purchased and traded, rather than the companies that generate these physical goods, these transactions are not securities transactions. This understanding was reflected in Chairman Gensler’s testimony in May 2021. It echoed a basic “regulatory gap” acknowledged by SEC staff in public internal discussions in 2018, as well as the limitations of SEC’s power in the digital asset field. Before the SEC’s recent regulatory overreach, no court had ever interpreted “investment contracts” as applying to independent asset sales or to any arrangements where the seller did not operate the business for the buyer’s benefit.

Argument 4: Digital assets, wallets, and staking functions are not securities, and the lawsuit is only the result of the SEC’s expanded definition

In a similar manner to Coinbase’s rejection of the application, this document uses the same logic to explain why digital assets, wallets, and staking services are not securities and do not require registration.

Coinbase stated that, especially in the past year, the SEC has significantly expanded its definition of investment contracts, thus expanding its own power over digital asset regulation. It did so by fiat, without justification, and without congressional authorization. Even as Chairman Gensler advanced this agenda, Coinbase has repeatedly sought to engage with the agency to understand and respond to its new positions. Coinbase even submitted a petition for rulemaking to the SEC in July 2022 to clarify which assets the Commission considers securities, among other issues. The petition has not yet received a response.

Argument 5: The power of interpretation should belong to Congress, not to agencies

Coinbase explains that the SEC’s claim of “securities” is limited to specific types of investment contracts. While the SEC’s interpretation may have some legitimacy, the “major questions doctrine” requires rejecting that interpretation while respecting Congress’s power to choose how to regulate “critical parts of the American economy.” This is because courts “presume that Congress has intentionally chosen to make fundamental policy decisions itself, rather than to delegate those decisions to agencies.” When an agency “claims to have discovered new powers to regulate critical parts of the American economy in long-existing regulations,” courts will not accept the agency’s “novel” legal interpretation without “explicit congressional authorization,” even if that interpretation is “reasonable” or “plausible.”

Argument 6: Even if the SEC has regulatory power, formal rulemaking procedures are required, not a lawsuit

Coinbase argues that even if the SEC has the necessary legal authority, the institution’s new interpretation of “investment contracts” needs to go through a formal rulemaking process. Declaring so-called regulatory power through punitive enforcement actions, rather than through a rulemaking process that informs and solicits opinions, is a violation of due process and an abuse of power, which in itself is enough to reject the claimed rights.

In the face of the SEC’s improper claims of power to fill existing regulatory gaps, federal courts have recognized the confusion the SEC has caused to market participants. As one court recently observed, “the regulatory agency itself seems unable to come to a consensus as to whether cryptocurrencies are commodities, subject to the CFTC’s regulation, or securities, subject to securities laws, or whether they are neither, or what standards should apply to make that determination.” As another court recently asked, “Why would it be wise for the Commission to delegate decisions of such profound economic significance in a multi-billion dollar industry to a single federal district judge?”

Coinbase later wrote that the SEC has chosen to advance its aggressive agenda through punitive retrospective enforcement actions, rather than by testing its new views through notice and comment rulemaking. The institution’s enforcement power is important, but not unlimited. The SEC’s actions here have exceeded these limits and should therefore be deemed illegal.

Argument 7: The SEC failed to give Coinbase any explanation or opportunity to cooperate and instead chose to sue directly

Coinbase illustrates this point with an example. On the same day that Coinbase submitted its application, the SEC sued a 32-year-old former Coinbase employee and his brother – the SEC v. Wahi case – alleging they used Coinbase’s confidential information to make early purchases of nine tokens on the Coinbase platform under the guise of “securities” fraud. The U.S. Department of Justice did not claim that these tokens were securities in its parallel action. But the SEC did so, and the lawsuit did not mention Coinbase or any issuer or developer of the tokens involved.

Therefore, the SEC’s interaction with Coinbase was not through any regulatory procedure, but through proxy litigation, leaving Coinbase’s asset listing decisions, its extensive compliance efforts, and years of interaction with the SEC to be defended by an unprepared and unsympathetic criminal (Wahi) who hurt the company. Faced with a motion to dismiss by the defendant and filings by Coinbase and other supportive friends of the court that revealed that the lawsuit exceeded the SEC’s statutory authority and violated due process (the basic flaws raised by Coinbase in this case), the SEC summarily terminated the Wahi lawsuit in a no-fault, no-admit, no-deny settlement. This part implies that the SEC attempted to prove that the tokens traded on Coinbase are securities through another completely unrelated case, without giving Coinbase any explanation opportunity.

Coinbase believes that the SEC’s enforcement is “retrospective accountability” rather than “forward-looking guidance,” leading to a series of other enforcement actions. As these actions increase, SEC Commissioner Hester Pierce points out that “using enforcement actions to tell people what the law is in emerging industries is unfair,” and she observes that “one-time enforcement actions and cookie-cutter analyses won’t work.”

Argument 8: Gary Gensler’s inconsistent remarks

In December 2022, Chairman Gensler told a reporter that he believed the SEC had enough power to fully regulate digital asset platforms. This is directly contrary to Chairman Gensler’s previous admission that Congress had not authorized the SEC to regulate digital platforms. However, during this 18-month period, no law has changed. Nevertheless, Mr. Gensler announced that digital asset platforms can and must immediately “come and talk to us and register.” However, Coinbase has already met with the SEC dozens of times and submitted applications to the SEC through rulemaking because there are currently no existing rules to regulate the registration of digital asset securities and digital asset exchanges. The SEC itself has claimed that “trading venues regulated by the SEC involve only securities.” As some senior SEC officials have acknowledged, Bitcoin and Ethereum are commodities, not securities, so exchanges that trade both commodities and securities cannot be registered. This is also one of the reasons why Coinbase’s listing process is designed to avoid listing assets that the SEC might designate as securities based on its previous statements.

Argument 9: Coinbase has always expected cooperation, but has been repeatedly rejected by the SEC

According to Coinbase, it continued to work with the SEC in late 2022 and early 2023. In more than a dozen demonstrations and more than 27 phone conversations, Coinbase shared its views on the possible structure of a registered digital asset securities trading platform with the SEC, as well as the feasibility of trading securities and non-securities on a single platform. The day before the planned meeting, which was originally intended for SEC staff to provide their first substantive response to Coinbase, the staff canceled the meeting and informed Coinbase that they would instead take enforcement action.

On March 22, 2023, SEC staff issued a Wells notice informing Coinbase staff of their intention to recommend that the Commission take enforcement action against the company. The Wells notice was issued while Coinbase was still providing documents to the SEC, and after staff had only taken testimony from two mid-level Coinbase employees. The SEC did not disclose the specific charges against Coinbase. In a conference call regarding the Wells notice, Coinbase directly asked: which assets traded on our platform are securities? The staff said they “had no way” of determining specific assets.

Argument 10: The SEC is ambiguous in its previous application for a restraining order in the third circuit court.

In the previous restraining order filed by Coinbase in the third circuit court, the SEC’s statements were completely contradictory. Coinbase claims that the restraining order was made in the context of “facing upcoming law enforcement actions with uncertain scope and timing, and the SEC has not made a decision on the company’s nine-month rule-making petition, let alone given any formal guidance on the basis of institutional expansion of regulation.”

Coinbase asked the Third Circuit Court of Appeals to order the SEC to “explain on the record whether it will initiate proceedings to establish rules against others and possible charges against Coinbase soon.” The reason for seeking assistance was clear: the SEC is enforcing new, previously undisclosed digital asset regulatory standards that are contrary to SEC officials’ previous statements and Coinbase’s DPO process. As part of proper administrative procedures and due process, Coinbase has the right to know the basis on which the SEC claims its newly discovered broad authority, or to challenge the SEC in court if it refuses to provide it.

In response to the restraining order petition, the SEC hesitated on May 15, 2023. It stated that it had not “secretly decided to reject” Coinbase’s petition. The SEC told the court that Coinbase’s proposal was “unfounded.” But on the same day in a public speech, Chairman Gensler expressed the opposite view, that no additional guidance was needed and the rules had already been published.

Coinbase’s legal response to the SEC’s lawsuit details the company’s position and views, claiming that it underwent a comprehensive review by the SEC prior to listing, complied with legal requirements, and followed business norms. This legal dispute will continue and may evolve into a long struggle. The debate between the two sides will determine the boundaries of responsibilities between the cryptocurrency exchange industry and regulatory agencies and the future direction of development.

Author: jk

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