Editor’s Note: The NYU Law Program on Corporate Compliance and Enforcement (PCCE) is following the SEC’s recent enforcement actions against major digital asset exchanges Coinbase and Binance and Binance’s founder, Chanpeng Zhao. In this post, cryptocurrency experts provide their insights to the SEC’s enforcement actions.
From left to right: Marc Fagel, Ijeoma Okoli, Daniel Payne, and Charles Senatore (photos courtesy of the authors)
Secondary Market Trading Finally Put To The Test
by Marc Fagel
The SEC’s back-to-back enforcement actions against two of the largest crypto exchanges, Binance and Coinbase, represent the most far-reaching crypto cases to date. Most of the SEC’s cases have focused on whether a particular issuer’s crypto offering violates the registration provisions of the 1933 Act. But the Binance and Coinbase cases put before the courts one of the most closely-watched legal issues in crypto: Whether secondary market trading of digital assets is governed by the federal securities laws.
In traditional cases involving stocks, bonds, and other instruments, this is a non-issue; nobody questions the asset’s perpetual coverage by the securities laws (including requiring the registration and regulatory oversight of intermediaries like brokers and exchanges). But the SEC has contended that digital assets are investment contracts, and precedent concerning secondary-market trading of investment contracts is limited. Absent an equity interest in or other privity with the issuer, does it make sense to treat the token as akin to a stock certificate? At least for those tokens which have some utility, crypto is arguably more like a currency or a product to be used in financial transactions. In such a case, treating the token as a security (and imposing on an exchange the same responsibility it has for overseeing the trading of other investments) seems anomalous.
Yet even a sweeping ruling in one or both cases—and that could be years off—is unlikely to resolve the debate. A broad determination that secondary market crypto trading is beyond the scope of the securities laws could have huge repercussions. While crediting some digital assets as having legitimate utility, there are thousands of crypto tokens in the wild, many (if not most) of which range from worthless to outright scams, and placing them outside the SEC’s purview leaves investors exposed. Conversely, finding tokens in secondary markets to be securities arguably denies legitimate actors in the space a clear mechanism for legal compliance, accepting as true the exchanges’ complaints about the lack of a feasible registration option. Either way, it may fall on Congress, not the courts, to chart a course that provides both investor protection and some path forward for crypto.
Marc Fagel is currently a law school lecturer, a retired Gibson Dunn partner, and a former SEC Regional Director.
The SEC Takes on The Crypto Sector’s Biggest Market Players
by Ijeoma Okoli
The SEC commenced enforcement actions against two of the world’s largest crypto exchanges, Binance and Coinbase, within 24 hours of each other in June 2023. Some of the allegations against the two were similar, e.g., engaging in unregistered offerings of securities and operating securities exchanges without SEC registration. Soon after the enforcement actions were announced, SEC Chair Gary Gensler told CNBC: “We don’t need more digital currency. We already have digital currency; its called the U.S. dollar; its called the euro; its called the yen….. We already have digital investments…. So what is the real underlying value of these tokens?”[1]
Putting aside the allegations in relation to violations of the Securities Act and Securities Exchange Act registration requirements contained in the enforcement actions, which I and many securities lawyers focused on the crypto sector expected to materialize sooner or later, some of the post enforcement action statements by the SEC Chair seem troubling. It is not the role of the SEC to dictate to Americans what items they need or items they can and cannot use their money to buy as long as the very act of purchasing the items is not illegal. Rather, the SEC’s mission is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”[2] The SEC, as Chair Gensler acknowledged to CNBC in the aforementioned CNBC interview, is meant to be merit neutral.[3]
Nevertheless, it was astonishing to discover to what lengths Binance allegedly went to conceal US customer access to its non-US trading platforms and flout US laws at the same time, according to the SEC’s enforcement action against the Binance companies and their founder and ultimate control person, Mr. Zhao. It was also astonishing to discover the level of manipulative trading practices and lack of controls on the platform to prevent such manipulative practices, in each case as alleged by the SEC. For example, in relation to one crypto asset security that was listed on the Binance.US trading platform, on one particular day, the SEC alleged that the market manipulation tactic of wash trading carried out by Binance affiliated entities accounted for as high as 35.5% of the trading volume of that crypto asset security on the platform.
Allegations like those detailed in the Binance enforcement action shine an unflattering light on condemnable actions of certain crypto market players. At the same time, in relation to alleged registration requirement violations of certain programs of crypto market players, as SEC Commissioner Hester Peirce suggested in her dissent[4] to the SEC’s enforcement action against Kraken’s staking-as-a-service program in February 2023, perhaps the solution to a registration violation is not to entirely shut down a program in an emerging industry that serves people well, but instead perhaps the SEC could engage in a public process to develop a workable registration process which would provide valuable information to investors.
[1] SEC Chair Gensler: We don’t need more digital currency (cnbc.com)
[4] SEC.gov | Kraken Down: Statement on SEC v. Payward Ventures, Inc., et al.
Ijeoma Okoli is a finance and regulatory lawyer and strategic adviser on digital assets; a co-Director of the Digital Economy Initiative, an independent digital assets think tank in London focused on US and UK digital assets public policy and a founding member and limited partner of Impact X Capital Partners, an ESG focused venture capital fund.
Damn the Torpedoes: The SEC Ignores Unprecedented Conflicts to Bring Cases Against Binance and Coinbase
by Daniel Payne
The recently-filed SEC v. Binance and SEC v. Coinbase cases mark the culmination of the SEC’s years-long enforcement campaign against the nascent cryptocurrency industry, but the SEC has not yet acknowledged the conflicts it faces in these cases. Indeed, the SEC may soon long for the early days of its cryptocurrency enforcement program given how in late 2017 and 2018, in the wake of the multi-billion-dollar ICO market mania of 2017, the SEC rolled over crypto defendants with ease. In cases like Munchee, AriseBank, Zaslavskiy, and Sharma, the SEC secured pre-filing settlements, default judgments, or early wins against defendants without the money or inclination to fight. The SEC was able to run that simple playbook for years until it went after a bigger fish: Ripple Labs. The SEC’s case against Ripple Labs and two Ripple executives has been bitterly fought since it was brought in December 2020. The SEC’s playbook has been torn apart in the Ripple case: well-funded defendants ably represented by some of the best attorneys in the country have racked up numerous wins on preliminary motions. The SEC has had to deal with multiple curveballs: tens of thousands of XRP holders, the supposed “victims” the SEC exists to protect, have lined up against the SEC, while the SEC itself has been put on trial as Ripple has received significant discovery into the SEC’s supposed preference for Ethereum over XRP.
But the Binance and Coinbase cases may create turmoil for the SEC far beyond even what it has seen in Ripple. There are unprecedented conflicts at the SEC in both cases. First, in Binance, the Binance defendants have made detailed allegations that Gary Gensler, before he became Chairman of the SEC, offered to serve as a regulatory advisor to Binance. Future-Chair Chair Gensler even had lunch with Binance’s CEO, Changpeng Zhao (“CZ”, also a named defendant), in March 2019, where they discussed Binance’s token, BNB, which the SEC has now alleged is an unregistered security. The SEC has not even acknowledged, let alone attempted to defend, the alleged massive conflict of interest in the SEC bringing a case against Binance and CZ given Chair Gensler is a material fact witness in the case.
The conflicts in the Coinbase case, meanwhile, implicate more than just Chair Gensler. As Coinbase has pointed out publicly, Chair Gensler testified to Congress on May 6, 2021 that the SEC does not have authority to regulate crypto exchanges. The SEC is now faced with the unenviable task of repudiating that testimony in federal court. Further, Coinbase went public in 2021 after the SEC approved its Form S-1. While the SEC notes in the complaint that declaring an S-1 effective is not an endorsement of the legality of an issuer’s underlying business, the SEC will have to respond to discovery around the S-1. What statements did the Division of Corporation Finance make to Coinbase while the S-1 was being drafted and, even more important, what do the internal SEC discussions about the S-1 look like? It is unclear whether the SEC is prepared for evidence of an irreconcilable conflict between internal statements by the Division of Corporation Finance and the Division of Enforcement. At least Binance and Coinbase understand the high stakes facing them. The SEC appears blissfully unaware of the unprecedented conflicts that may undermine these cases from the very beginning.
Daniel Payne is a Senior Fellow at the International Congress of Blockchain Advisors and serves as in-house counsel to blockchain brands.
Regulators Should “Lean in” to Providing Guidance to Crypto Businesses
The recent serial announcements of SEC enforcement actions against Binance and Coinbase has created a stir in digital asset circles. The Commission’s decision to target major household names in the space clearly has gotten the attention of the industry.
Coinbase has taken the position that the business practices in question do not involve the securities laws. They apparently had over 40 meetings with the SEC staff to hash this out. They seem to have conviction and are not settling. We will find out after a long and expensive litigation whether the courts ultimately agree with Coinbase’s position.
Regulatory uncertainty is not only costly. It stifles and hinders innovation. The Howey test determining whether something is a security is itself subject to varied subjective interpretations, largely governed by a facts and circumstances analysis. It is exposed to the danger of differing interpretations, an example of which seems to be playing out in a potential disagreement between the SEC and the CFTC as to whether Ethereum should properly be deemed a security or a commodity.
There is an opportunity for regulators to lean into actively engaging with market participants to mitigate the problem of regulatory uncertainty. Each of our regulators has innovation offices akin to the SEC’s Finhub office, with a mandate to engage market participants in good faith, to provide guidance and to help reasonably resolve uncertainty.
The SEC has embraced this concept. In its 2017 Statement on the Report of Investigation on the DAO, the Divisions of Corporation Finance and Enforcement emphasized cooperation with the industry. The Divisions recognized that “distributed ledger and other emerging technologies have the potential to influence and improve the capital markets and the financial services industry,” and “encourage(d) market participants who are employing new technologies … to contact our staff, as needed, for assistance, of analyzing the application of the federal securities laws.”
Congress is working to address the issues facing the industry. Until then, a staff that is empowered to provide good faith guidance to market participants can contribute significantly to creating clarity and promoting responsible innovation.
Charles V. Senatore is a PCCE Senior Fellow, a current board member, a former SEC regional director, and a former federal prosecutor.
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