The SEC's lawsuit accusing cryptocurrency exchange Coinbase of operating as an unregistered securities broker has survived its first legal challenge, opening the door for the case to go to trial.

In an order [PDF] handed down in New York City on Wednesday, federal district Judge Katherine Polk Failla said America's financial watchdog had reasonably argued in its original complaint, filed last June, that Coinbase was operating as a unregistered securities exchange, broker and clearing agency. 

"The 'crypto' nomenclature may be of recent vintage, but the challenged transactions fall comfortably within the framework that courts have used to identify securities for nearly eighty years," the judge said. 

Coinbase had tried to get the SEC's lawsuit against it dismissed, and did manage to get one of the five charges thrown out, namely that it acted as an unregistered broker by offering its Wallet application to customers.

According to the judge, Coinbase's Wallet app allows customers to hold custody of their own cryptocurrency keys, and doesn't have any brokerage or exchange capabilities in and of itself. To buy and sell cryptocurrency using the Wallet app, Coinbase users instead have to connect to other third-party exchanges. 

"Coinbase has no control over a user's crypto-assets or transactions via Wallet, which product simply provides the technical infrastructure for users to arrange transactions on other [decentralized exchanges] in the market," Judge Failla said. As such, the app's maker isn't responsible for users' decisions and actions with their Wallet-held money, whether or not Coinbase takes a one percent cut of the transactions as a fee.

The biz simply doesn't act as a broker with regards to Wallet; it acts as a provider of software that holds a wallet's keys, in other words.

As for the rest of the case, the judge said it meets the threshold established by the Howey test, derived from a case between the SEC and the WJ Howey Company that was settled by the US Supreme Court in 1946. The test is used to determine whether an asset can count as an investment contract. According to Judge Failla, the SEC's argument meets that bar.

"The court finds that the SEC has adequately pleaded that Coinbase customers engaged in transactions involving the Crypto-Assets that amounted to 'investment contracts' under Howey," Failla said. 

"Both the SEC and private litigants have brought several successful actions in this circuit predicated on crypto-assets falling within the Howey definition of an 'investment contract,'" Failla added, citing cases filed by the watchdog against Telegram and Terraform. 

It's now up to Coinbase to show at trial why the SEC is wrong in its assertion that it is therefore an unregistered securities broker. The exchange says it's ready to argue its case.

Paul Grewal, Coinbase's chief legal officer, said the outfit was prepared for the court's latest decision and that he looks forward to uncovering more about how the SEC considers crypto regulation, as part of the discovery process. 

"We remain confident in our legal arguments, we look forward to proving we're right, we are eager for the opportunity to take discovery from the SEC for the first time," Grewal said on X today. 

"We’re pleased that yet another court has confirmed that, while the term ‘crypto’ may be relatively new, the framework that courts have used to identify securities for nearly 80 years still applies," an SEC spokesperson told The Register.

"When intermediaries don’t register [as brokers], it’s investors who get hurt and the American financial markets that suffer. We will continue to protect investors against risks in the crypto markets when, as here, the securities laws are implicated."

The SEC is also in the midst of a trial against Binance, one of the largest cryptocurrency exchanges by volume. The commission has accused Binance of much of the same unregistered securities charges that it leveled against Coinbase, with the addition of fraud accusations for allowing US-based customers to access its overseas exchanges after the platform was banned in the US in 2019. ®

https://www.theregister.com//2024/03/27/sec_coinbase_court/