Is Coinbase right, and are the US authorities wrong? The surprising arrest of the exchange’s former executive highlights a hole in regulation

The USA Securities and Exchange Commission (SEC) has equated nine cryptocurrencies with securities. The decision is stated in the documents of the seizure case of former Coinbase manager Ishan Wahi on suspicion of insider trading. These digital assets are AMP (AMP), Rally (RLY), DerivaDEX (DDX), XYO (XYO), Rari Governance Token (RGT), LCX (LCX), Powerledger (POWR), DFX Finance (DFX), and Kromatika (KROM).

So what is security?

Security is a traded financial asset with a monetary value. It represents an owner’s position in a publicly traded corporation (through the ownership of stock), a creditor’s relationship with a governmental body or corporation (through the ownership of bonds), or ownership rights represented by an option. In the USA, security is a traded financial asset of any kind. According to the SEC, security is “an investment of money, in a common enterprise, with a reasonable expectation of profit derived from the efforts of others.”

The SEC has set a precedent. Why and what’s the point?

Coinbase filed a petition with the SEC to improve “rulemaking on digital asset securities.” The company said that cryptocurrency is traded differently than securities, and these differences should be considered and spelled out in the law. That’s because Coinbase offers seven of them.

Now the SEC decision means that the cryptocurrency platform must classify some of the cryptocurrencies it offers as regulated financial instruments. The listing process for securities, such as company stock, includes strict disclosure and registration requirements.

“Crypto assets that are securities need an updated rulebook to help guide safe and efficient practices. Crypto assets that are not securities need the certainty of being outside those rules. Anything short of that will entrench incumbent technologies at the expense of innovation and, ultimately, consumers. That’s why we have submitted a petition to the SEC to request that it develop rules that work for digital asset securities,” the company stated.

Coinbase believes that securities law is inappropriate for regulating digital assets. Trying to apply such inconvenient rules to crypto would create such problems:

• lack of regulation for the subset of crypto assets that are securities;
• so many different steps and intermediaries that there is no way trades can settle in real-time;
• it is effectively impossible for individual investors to trade directly without using a broker; and
• blockchain technology is not able, under the current rules, to be used as a reliable record of transactions, even though this is the innovation that makes distributed ledger technology so powerful.

How the U.S. securities market is regulated

The Securities Act of 1933 is the federal law that requires that securities sold to the public be registered with the SEC and that complete information about the seller and the stock offering is made available to investors. The Securities Act of 1934 regulates the operation of stock exchanges and trading. One primary responsibility of Securities lawyers is to help their clients navigate these complicated federal and state regulations.

There are public and private offerings of securities. A public offering is when a security is offered to the public — usually in the context of the bank acting as an underwriter and buying the entire issue of securities at a specific price for resale to the public. It requires a letter of agreement and filing a disclosure statement with the SEC. Disclosure statements can be very complicated (including information about the stock issuer’s business, liabilities, financial condition, and business prospects). Typically, a stock offering requires SEC review and lengthy conversations between the SEC and the lawyer representing the issuing entity. Once the SEC is satisfied that the information has been adequately disclosed, the registration statement goes into effect, and the sale of securities can begin.

On the other hand, private placement of securities is simply the sale of stock or debt to a limited group of investors. A private offering does not require the issuing company to file a disclosure statement with the SEC. Still, it does require that the personal disclosure statement be distributed to potential investors.

Once the registration statement becomes effective, compliance with the Securities Acts of 1933 and 1934 begins. The laws require the regular filing of reports to keep public security holders informed of the state of the organization. Issuers must also file quarterly and annual reports describing the organization’s operating and financial condition. If there is a “voting class” of stock, the organization must prepare and distribute proxy statements allowing shareholders to vote at the annual meeting. There are also requirements that directors, officers, and significant shareholders disclose their ownership interests. The organization must comply with the exchange rules if the shares are traded on a stock exchange.