SEC sues Coinbase as pressure on crypto world rises

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The Securities and Exchange Commission filed a lawsuit against cryptocurrency exchange Coinbase Global (COIN) as the regulator turns up its pressure on the crypto world.

The SEC alleges Coinbase, the largest crypto exchange in the US, violated securities laws by acting as an exchange, a broker and a clearing agency without registering with the agency. It also offered and sold securities without registering its offers and sales, the SEC said.

The US lawsuit filed in the Southern District of New York came a day after the SEC sued the world's largest crypto exchange, Binance, for violating securities laws, mishandling customer funds and misleading investors. Ten states, led by California, also sued Coinbase for allegedly violating state securities laws.

Coinbase's chief legal officer Paul Grewal, appearing before a House Agriculture Committee Tuesday to discuss how the crypto industry could be regulated, said "it's disappointing but not surprising that the SEC has decided to bring legal action against Coinbase today."

He and Coinbase CEO Brian Armstrong in separate statements confronted the SEC, arguing that the agency was being overly aggressive without establishing clear rules for their industry.

"The SEC has taken a regulation by enforcement approach that is harming America," Armstrong said on Twitter. "So if we need to avail ourselves of the courts to get clarity, so be it."

Coinbase stock fell 12% Tuesday, but other cryptocurrency assets rebounded over the course of the day. Bitcoin rose to $26,700, for a 24-hour rise of 4.3%, and the total market capitalization for crypto assets was up 3%.

Binance’s token, BNB (BNB-USD), gained 3.8% on the day but remains down 1.8% for the past week.

As of 10 a.m. New York time, Binance had lost $1.43 billion in net flows, the largest withdrawal amount by customers in a 24-hour period since December 12, according to crypto data provider Nansen.

Binance maintains approximately a 54% market share of global crypto trading volume through its various subsidiaries, according to research firm Kaiko. Coinbase accounts for 6.5% of global volume and 53% of US trading volume.

High-profile clashes

The two new complaints from the SEC represent the latest of many recent high-profile clashes between US regulators and the larger crypto world.

Since the beginning of the year, the SEC has charged 15 different crypto actors with violating securities laws. US crypto exchange Kraken paid $30 million in fines to settle SEC charges in February, for allegedly violating securities rules by failing to register its crypto asset staking program.

"The dragnet that the SEC has put out against crypto continues," Mark Palmer, Berenberg Capital Markets senior equity research analyst told Yahoo Finance Tuesday. "And we don't think that it will stop anytime soon."

Coinbase first warned of a potential action in a March 22 regulatory filing, saying it received a Wells Notice stating that SEC staff had made a "preliminary determination" to recommend an enforcement action for violations of federal securities laws.

Coinbase then sued the SEC in April, asking a federal judge to force the regulator to publicly share whether it would propose new securities rules for digital assets or extend existing securities rule-making processes to the asset class.

Brian Armstrong, CEO and Co-Founder, Coinbase, speaks during the Milken Institute Global Conference on May 2, 2022 in Beverly Hills, California. (Photo by Patrick T. FALLON / AFP) (Photo by PATRICK T. FALLON/AFP via Getty Images)
Brian Armstrong, CEO of Coinbase. (Photo by Patrick T. FALLON / AFP) (Photo by PATRICK T. FALLON/AFP via Getty Images) (PATRICK T. FALLON via Getty Images)

These legal battles could help establish how, and whether, cryptocurrencies are regulated in the US. One key area of debate is whether certain digital currencies are commodities or securities and therefore fall under the oversight of the CFTC and the SEC.

Last week House Financial Services Committee Chair Patrick McHenry (R-N.C.) and House Agriculture Committee Chair Glenn Thompson (R-Penn.) unveiled a draft discussion bill as a possible framework to regulate cryptocurrency.

The draft bill aims to create clarity around gaps between the rules of the CFTC and the SEC. It also tries to direct what firms need to do need to register with the SEC and requires the SEC to write new rules that are customized to govern crypto.

Grewal, Coinbase's chief legal officer, said Tuesday before the House Agriculture Committee that "the solution is legislation that allows fair rules for the road to be developed transparently and applied equally, not litigation.”

Coinbase's CEO said on Twitter that "SEC and CFTC have made conflicting statements, and don't even agree on what is a security and what is a commodity." The SEC, he added, reviewed Coinbase's business and allowed it to become a public company in 2021.

Coinbase's chief policy officer Faryar Shirzad told Yahoo Finance in March that it tried to register with the SEC but never heard back.

"There's no path to registering," Shirzad told Yahoo Finance during that interview. "We've tried, and there's just no way to do it."

Grewal made that same point again Tuesday before the House committee, calling the company's dialogue with the SEC a "monologue."

Since getting the 2021 approval to become a public company, he said the company had "over 30 engagements" with the SEC to "to try to work towards a sensible framework for regulation" that would allow the registration of platforms as either broker dealers or a national security exchange.

"We received no response," he said.

'Reputational damage'

The basis for the SEC’s new complaint is that certain crypto assets Coinbase offers to customers are securities, and therefore under the SEC's jurisdiction.

It charged Coinbase with the unregistered sale of crypto securities through its staking program and accused the company of “commingling” services separated in traditional securities markets.

“In other parts of our securities markets, these functions are separate," said SEC Chair Gary Gensler. "Coinbase’s alleged failures deprive investors of critical protections, including rulebooks that prevent fraud and manipulation, proper disclosure, safeguards against conflicts of interest, and routine inspection by the SEC."

The agency made some of the same claims in its case against Binance and its founder Changpeng Zhao on Monday.

The SEC claimed 11 crypto tokens Binance listed for trading also classified as securities, including BNB, Solana (SOL-USD), Cardano (ADA-USD), MATIC and ALGO (ALGO-USD). Between Binance and Coinbase the SEC now claims a total of 19 crypto tokens are securities. That sum accounts for roughly 11% of crypto's total market capitalization.

Those classifications may pressure other exchanges in US markets to de-list these assets or risk facing the SEC's ire.

Changpeng Zhao, Binance's Chief Executive Officer attends the B20 Summit, ahead of the G20 leaders' summit, in Nusa Dua, Bali, Indonesia, November 14, 2022. REUTERS/Willy Kurniawan
Changpeng Zhao, Binance's founder. REUTERS/Willy Kurniawan (Willy Kurniawan / reuters)

“If found guilty, the reputational damage alone could be significant, leading to a loss of trust from users and backers,” said Mikkel Morch, chairman and director for crypto hedge fund ARK36.

He cited fines, a shutdown of US entity Binance US and increased scrutiny for the international exchange in other jurisdictions as possible outcomes.

In the SEC’s complaint, the regulator alleges Binance violated federal securities laws by courting US investors while displaying a lack of internal controls including compliance and risk-related measures. The SEC also alleges the trading venue misled investors by purporting separation between it and the US entity, Binance.US

The charges heap even more legal pressure on Binance following a similar lawsuit in March from the Commodities and Futures Trading Commission, which alleged Binance offered unregistered derivatives to US crypto traders.

Investor enthusiasm

Investor enthusiasm for the crypto world is waning amid the regulatory scrutiny. Total crypto market volume across exchanges fell 40% through April and another 25% in May, according to JPMorgan.

“We think this regulatory risk particularly in the US is pressuring token prices and activity levels seen as the industry overall underperformed this month,” JPMorgan analyst Kenneth Worthington said in a Tuesday note.

“The lack of major catalytic events and continued regulatory pressure from the SEC are weighing on investor enthusiasm and ultimately activity levels,” Worthington added.

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