Coinbase seeks court dismissal of SEC lawsuit over regulatory violations

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In a Wednesday court hearing, Coinbase asked the federal judge in Manhattan to dismiss the Securities and Exchange Commission’s (SEC) lawsuit alleging it had violated regulations.

In June 2023, the SEC filed a lawsuit against Coinbase, alleging that the platform allowed the trading of 13 crypto tokens — such as Solana, Cardano and Polygon — without proper registration as securities.

SEC and Coinbase agreed that the tokens in question are not securities. However, the SEC contended that each trade is like an investor entering a token ecosystem, aiming to profit from its gains. Coinbase argued that these are secondary-market trades without a contract and should not be classified as securities.

Judge Katherine Polk Failla considered arguments from both parties, focusing on the legal definition of securities and the characteristics of certain crypto tokens labeled as investment contracts by the regulator.

After a lengthy four-hour hearing, Judge Failla did not make an immediate decision, mentioning that she was still considering some questions. Her decision is anticipated to influence the digital asset sector by offering clarity on the SEC’s jurisdiction in the field.

This case is part of a series initiated by the SEC against the crypto industry, which initially focused on companies selling digital tokens. Under Chair Gary Gensler’s leadership, the SEC has expanded its focus to include trading platforms, clearing activities and entities acting as broker-dealers in the cryptocurrency space.

Coinbase challenges crypto assets labeled as investment contracts

Coinbase believes that crypto assets, unlike stocks and bonds, do not fit the definition of an investment contract — a view shared by most of the crypto industry.

However, SEC assistant chief litigation counsel Patrick Costello asserted that the crypto tokens central to the case represent a broader “enterprise,” likening them to an investment contract.

“When the value of the network or the ecosystem increases, so does the value of the (associated) token,” he said.

Failla told SEC attorneys that she was troubled by the agency’s request to broaden the definition of securities.

The SEC argued that individuals buying digital assets, even on platforms like Coinbase’s secondary market, were treating the tokens as investments similar to stocks or bonds.

“It’s the same computer code no matter which one of us has it,” said Costello. “The token is the key that gets you into the ecosystem. The token is worthless without the ecosystem.”

However, Coinbase’s legal team disagreed, emphasizing that buyers of these tokens did not enter into contracts granting them proceeds from a shared venture.

“I’ll tell you this: I think there would have been a lot of surprise to find that an investment contract didn’t have anything to do with a contract,” said Coinbase lawyer William Savitt.

Savitt emphasized the importance of a statement conveying an enforceable promise for a contract to exist. He reiterated that without such a statement, a contract does not exist.

Costello aimed to counter concerns that the SEC’s stance might broaden the definition of securities to include items like art or trading cards. He argued that these assets lack the central ecosystem characteristic.

“Collectibles have their own value,” he said. “There’s no way for somebody to make a baseball card more valuable.”

SEC lawyers asked Judge Failla to reject Coinbase’s claims, saying that the exchange gave customers the impression that specific digital assets bought on the platform would increase in value.

Savitt acknowledged that buyers on Coinbase might anticipate an increase in the value of their digital assets, but he contended that this alone is insufficient.

“Agencies have authority, and the commission has broad authority within the world of securities to regulate,” he said. “But it does stop at the water’s edge.”

Bloomberg Intelligence senior litigation analyst Elliott Stein stressed that Coinbase might encounter a $1 billion liability from the SEC. However, he believes there’s a 70 percent chance that the exchange will ultimately succeed in the case.