SEC Files First Crypto Insider Trading Case, But the Trading Doesn’t Involve a Security

Three people have been charged in the first-ever crypto insider trading tipping scheme. The charges are generating an interesting series of discussions, because this is an SEC case, but the asset purchased as a result of the information may not be a security.

This starts with a DOJ charge and an SEC charge, filing insider trading charges against a former Coinbase product manager, his brother, and his friend for allegedly perpetrating a scheme to trade ahead of multiple announcements regarding certain crypto assets that would be made available for trading on the Coinbase platform.

The defendants are NOT accused of trading Coinbase’s securities, which would be the traditional insider trading case, but rather that the information tipped included what crypto assets or tokens would be made available for trading.

According to the SEC’s complaint, Coinbase treated such information as confidential and warned its employees not to trade on the basis of, or tip others with, that information. However, from at least June 2021 to April 2022, in breach of his duties, Ishan repeatedly tipped the timing and content of upcoming listing announcements to his brother, Nikhil Wahi, and his friend, Sameer Ramani. Ahead of those announcements, which usually resulted in an increase in the assets’ prices, Nikhil Wahi and Ramani allegedly purchased at least 25 crypto assets, at least nine of which were securities, and then typically sold them shortly after the announcements for a profit.

The SEC is going to have real problems with this case, and the defendant’s motion to dismiss will be interesting. The problem is that insider trading, by definition refers to purchasing or selling a security while in possession of material, non-public information concerning that security, where the information is obtained from a breach of fiduciary duty, or a duty arising from a relationship of trust or confidence.

The problem is that the inside information here, the upcoming listing by Coinbase of certain crypto assets, and the purchase of those assets, has nothing to do with the value of Coinbase or its securities.

Therefore, the SEC has to make the case that the crypto assets at issue are themselves securities. Of course, the SEC has never taken that position, and to our knowledge no court has ever held that any of the crypto assets at issue are securities.

What is a security?- The SEC in its complaint simply skips over this question, and simply concludes that the crypto assets are securities.
First, the leading Supreme Court case, SEC v. Howey Co., provides a full analysis of the definition. Boiling that analysis down to a sentence, a security is “an investment of money in a common enterprise with profits to come solely from the efforts of others; and, if that test be satisfied, it is immaterial whether the enterprise is speculative or nonspeculative, or whether there is a sale of property with or without intrinsic value”. SEC v. Howey Co., 328 U.S. 293 (1946)

And the SEC does not address this issue in the complaint, The complaint states, as if it was a fact,  that the crypto assets are securities, and does so in two paragraphs,

24. A digital token or crypto asset is a crypto asset security if it meets the definition of a security, which the Securities Act defines to include “investment contract,” i.e., if it constitutes an investment of money, in a common enterprise, with a reasonable expectation of profit derived from the efforts of others. As described in greater detail below, during the relevant period, Ishan provided material, nonpublic information about, and Nikhil and Ramani traded in, at least nine crypto asset securities that meet this definition.

I should point out that the “greater detail below” is nothing more than a timetable of facts, unrelated to describing an investment of money in a common enterprise.  

25. After the initial sale by the issuer, crypto assets are often traded on secondary trading platforms, such as Coinbase. Crypto asset issuers may apply to these trading platforms to have crypto assets listed and made available for trading; the trading platforms select what crypto assets may be bought and sold on their systems. The existence of the secondary trading market offered by platforms such as Coinbase allows market participants to buy and sell crypto assets, including crypto asset securities. Secondary market trading in crypto assets has grown exponentially, and the announcement of the listing of a crypto asset, including a crypto asset security, on Coinbase typically causes that asset’s price and trading volume to rise dramatically.

Wait. lists used cars for purchase and sale (“trading”) and the secondary market for used cars has grown exponentially, and listings on Carvana have undoubtedly caused used car prices and volume to rise. Are used cars now a security?

We will have to wait and see what a court has to say about this, but once again the SEC is attempting to regulate by litigation, not legislation. 
This is simply wrong, it is exactly what they are doing in the dealer regulation space. It is unconstitutional, and quite simply unfair. The SEC is adding rules and changing definitions, then suing people for violating rules or definitions that did not exist at the time of their conduct.
And in case you think I am simply a securities defense attorney arguing defenses, CNBC is reporting:

Caroline Pham, commissioner of the Commodity Futures Trading Commission, also weighed in on the case Thursday, calling the SEC securities fraud charges a “striking example of ‘regulation by enforcement.’” The CFTC oversees foreign exchange trading.

“The SEC’s allegations could have broad implications beyond this single case, underscoring how critical and urgent it is that regulators work together,” Pham said in a statement. “Regulatory clarity comes from being out in the open, not in the dark.”

Coinbase’s Grewal concurred with Pham’s assessment.

“Instead of crafting tailored rules in an inclusive and transparent way, the SEC is relying on these types of one-off enforcement actions to try to bring all digital assets into its jurisdiction, even those assets that are not securities,” he said in the blog post.