January 19, 2024

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Good morning and happy Friday. This week's newsletter is dedicated to everyone aspiring to make crypto more than just a "rounding error."

Top Points

• Attorneys for the SEC and Coinbase argued their cases in front of Judge Failla as to whether Coinbase violated federal securities laws.
• Senators Bill Hagerty (R-TN) and Cynthia Lummis (R-WY) introduced a bill that would create a pilot program for federal agencies and crypto firms to share information to detect and combat illicit finance activity.

SEC v. Coinbase - Oral Arguments on Motion to Dismiss

On Wednesday, the SEC and Coinbase presented oral arguments on Coinbase's motion to dismiss SEC claims that Coinbase operated as an unregistered securities exchange, broker, and clearing agency, and offered its staking program as an unregistered security.

Key Takeaways:

• It was clear that Judge Failla carefully reviewed the pleadings and each amicus brief, and that she has a deep understanding of the technical facts underlying the case.
• Judge Failla pressed both sides on their arguments as to what does – and what does not – constitute an investment contract.
  • In particular, Judge Failla seemed concerned that the SEC’s proffered argument fails to contain a clear limiting principle to distinguish investment contract securities from non-security assets, like commodities and collectibles.
  • "It is a real fear that I have that you are sweeping too broadly."
• Judge Failla sounded cautious about applying the Major Questions Doctrine because she wants to make sure she "stays in her lane," especially when applying a doctrine specifically aimed at protecting the separation of powers and typically reserved for exceptional circumstances.
• Next, Judge Failla will continue to carefully review the arguments and issue a decision in the weeks ahead.

Here's a closer look at some of the key issues presented.

Procedure/Facts

At this stage of litigation, Coinbase is asking the court to dismiss the claims based on the pleadings filed pursuant to Rule 12(c). Under Rule 12(c), the court must base its decision on the pleadings and draw all inferences in favor of the SEC. In other words, Coinbase is arguing that even if all of the facts alleged by the SEC are true, the case must still be dismissed because the SEC's allegations fail to show that Coinbase violated the law.

With this in mind, Judge Failla asked several questions to both sides aimed at clarifying the scope of material that she could consider for purposes of this motion. For example, the issues of whether Coinbase's staking program constitutes an investment contract offering and whether Coinbase Wallet functions as a broker are fact-intensive. And both sides' description of Coinbase's staking service and wallet functions departed significantly. Tellingly, Failla noted her great appreciation for the careful explanation of staking and wallets included in the DeFi Education Fund's amicus brief. But the SEC tried to persuade Judge Failla that such factual disputes should not be resolved for purposes of this motion.

What Is an Investment Contract Security?

The SEC's registration violation claims hinge on whether at least one crypto asset available for trading on Coinbase is a security. If none of the crypto assets are securities, the registration requirements under the securities laws would not apply.

Thus, here, the SEC argues that at least 12 "crypto asset securities" on Coinbase are investment contracts (and thus securities) under the Howey test because users: (1) invest money when they buy tokens, (2) in the common enterprise of "the token’s network" or "ecosystem," (3) and expect profits based on the efforts of the issuer and their project teams to boost the token's value (e.g., developers building the network and project teams promoting the token via public statements). Importantly, the SEC concedes the tokens themselves are not securities. Still, the agency argues the court must look to the "totality of circumstances" and "inducements" surrounding the investment in a token.

Coinbase counters that the plain text of the Securities Exchange Act of 1934, the state court decisions on which the Howey decision is based, previous SEC briefings, and Howey's progeny all dictate that an "investment contract" only exists where there is a contract. Or, at the very least, where an asset carries an implied promise of an enforceable right against the issuer (e.g., a right to dividends). And here, Coinbase says the alleged crypto asset securities do not travel with any such rights or promises. Instead, they are merely traded via blind bid/ask transactions without the buyer having any expectation of receiving an enforceable right against the token issuer in exchange for their investment.

On this issue, Judge Failla is acutely concerned with how the law develops and what her ruling will mean. To this end, she firmly pressed the SEC to explain why its view of Howey would not sweep in virtually every commodity or collectible (e.g., beanie babies or baseball cards). In this way, Failla appeared sympathetic to Coinbase's argument that something more is needed to ensure there are meaningful limits to the SEC's "investment contract" reach.

Notably, the SEC attempted to distinguish Bitcoin - which it says is not a security - from crypto assets that are investment contracts on the the grounds that "there is no ecosystem behind Bitcoin."

Major Questions Doctrine

Under the Major Questions Doctrine ("MQD"), courts may reject an agency action where it has departed from its previously asserted authority on matters of economic and political significance and fails to point to "clear Congressional authorization" for doing so. This judicial doctrine aims to protect the separation of powers between the legislative and executive branches.

Coinbase argues that the MQD precludes the SEC's claims here because the SEC is departing from its previous interpretation of investment contract to grab power Congress has not granted it. In support, Coinbase cites numerous legislative proposals in Congress aimed at addressing the regulatory gap for the crypto spot market. Coinbase also points to prior statements by Chair Gensler himself acknowledging the regulatory gap in the crypto spot market before Congress.

The SEC counters that it is merely adhering to the will of Congress by enforcing the Securities Exchange Act of 1934 as passed by Congress and interpreted by Howey. Further, the SEC argues crypto is not of sufficient economic significance to warrant the MQD. Indeed, an SEC attorney described crypto as a mere "rounding error" compared to global capital markets.

Judge Failla sounded cautious about applying the MQD here. For example, she told Coinbase she would "like a little more comfort" to know she's "staying in her lane" if she applies this doctrine generally reserved for exceptional circumstances.

Judge Failla did appreciate Senator Lummis's amicus brief in support of protecting Congress's right to address crypto regulation through legislation. When asked by Judge Failla to address the Senator's arguments, the SEC responded that the views of one Senator should not replace the will of the entire Congress that enacted the Securities Exchange Act of 1934.

Looking for a more in-depth play-by-play? Here are two tweet threads covering the full hearing:

​Lewis Cohen, Co-Founder, DLx Law LLP:

​Leo Schwartz, Reporter, Fortune:

Preventing Illicit Finance Through Partnership Act of 2024

On Wednesday, Senators Bill Hagerty (R-TN) and Cynthia Lummis (R-WY) introduced the Preventing Illicit Finance Through Partnership Act of 2024.

The bill would create a voluntary pilot program for federal agencies, crypto firms, and money services businesses to share information about potential threats, emerging risks, and illicit activity involving crypto assets. § 2(b).

The Attorney General ("AG") would be responsible for establishing the program and must designate 10 money service businesses and 10 crypto companies to participate. § 2(c)(1). The AG may also designate "1 or more information sharing and analysis center(s)" to participate. § 2(c)(2).

The DOJ, FBI, DEA, FinCEN, and Department of Homeland Security would be the federal agencies participating in the pilot program. § 2(a)(1).

So What?

Because the bill lacks a Democrat sponsor, it is unlikely to move forward in the Democrat controlled Senate. Still, it shows even pro-crypto Republicans in the Senate want to address illicit finance concerns. But unlike previous proposals in the Senate like DAAMLA and CANSEE, this bill offers an alternative approach whereby federal agencies would be encouraged to work with crypto firms to combat illicit finance, rather than simply view the industry as a target.

The bill is also timely. Politico's Eleanor Mueller reported on Wednesday that Senate Banking Committee Chairman Sherrod Brown (D-OH) plans to continue talks on various legislative proposals to address money laundering in crypto over the next few weeks.

Look Ahead

• The House is in recess next week, but the Senate will hold a couple of AI focused hearings on Wednesday:
  • Senate Judiciary - Wednesday (1.24) - 2:30PM - Hearing to examine AI in criminal investigations and prosecutions.
  • Senate Rules and Admin - Wednesday (1.24) - 3pm - Hearing to examine the use of AI at the Library of Congress, GPO, and Smithsonian Institution.
• New Hampshire Presidential Primary - Tuesday (1.23).

Quick Hits

Tax

• The IRS clarified that new tax reporting requirements for businesses who receive over $10,000 in a certain crypto transactions are delayed until the agency issues further guidance.
• In response, HFSC Republicans called for passage of the Keep Innovation in America Act to provide a permanent statutory fix:

Admin Law/Chevron Deference

In Loper Bright Enterprises v. Raimondo, the Supreme Court heard oral arguments on how much deference courts should afford federal agencies when they interpret federal law. Crypto and the SEC made it into the arguments:

More SEC in the Courts

• In SEC v. Debt Box, the court is considering sanctioning the SEC for making false or misleading statements to the Court. On Monday, Debt Box filed their reply brief on the issue:

2024

• Trump vows to oppose a Central Bank Digital Currency (Julia Shapero; The Hill).

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Thank you for reading and please enjoy your weekend.

Sincerely,

GSL

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*All information contained in this newsletter is for informational purposes only and should not be considered legal or financial advice. You should conduct your own research, and consult an independent financial, tax, or legal advisor before making any investment decisions. The author may own cryptocurrencies discussed herein.*