United States District Judge Katherine Polk Failla has heard arguments from the Securities and Exchange Commission (SEC) and Coinbase on the crypto exchange’s motion for dismissal of a lawsuit filed by the regulator in June 2022.
The hearing was held for nearly five hours and provided an extensive overview of the key arguments in courts regarding the crypto space, assets and the SEC's role in regulating the industry.
During the hearing, Judge Failla critically examined the regulator’s case against the crypto exchange, asking the SEC attorneys to explain why a digital token issuance would meet the Howey test, arguing the case was “too broad.”
In the SEC’s view, buyers of tokens are also investing in the network or ecosystem behind it, indicating there is a value proposition behind a token purchase. Coinbase’s attorneys, however, challenged the argument, claiming that Bitcoin — described as a commodity by an SEC attorney during the hearing — is also backed by a community and has a network.
Judge Failla delved into the definition of staking and secondary market transactions, as well as recent court rulings involving crypto firms, such as the Ripple and Terraform Labs case. Cointelegraph has summarized the hearing’s hottest topics below.
Coinbase is trying to create a different Howey test, says SEC
Attorneys representing the SEC argued that the exchange is trying to create a different version of the Howey test while allowing trade of crypto tokens that offer holders access to ecosystems that the regulator described as a "common enterprise."
The SEC argued that the exchange independently conducted the Howey test, leading to differing interpretations regarding the status of certain tokens. This discrepancy in conclusions over the tokens regarding the test, according to the SEC, provides sufficient grounds to reject the motion and allow the case to proceed.
“We think they’re making up a new test, and we believe that our position is the one that’s most faithful and consistent, but in fact, compelled by the Howey test. It’s not just a plausible reading, as they claim it is.”
SEC v @coinbase Update IV
— MetaLawMan (@MetaLawMan) January 17, 2024
In an unusual move, the Judge dispensed with any prepared arguments from either side and instead went straight to questioning the lawyers.
The first 2 hours was spent exclusively questioning of the SEC lawyers.
The SEC lawyers were better prepared…
Terraform Labs case enters the stage
During the hearing, the SEC discussed a recent ruling on Terraform Labs that concluded it sold digital assets as securities without registration. The decision, according to the SEC, provided further grounds for its case against Coinbase.
The topic was heavily discussed over the hearing. As per SEC attorneys, the cases of Ripple and Terraform Labs may differ from Coinbase's one, but the Howey test applies exactly in the same way.
“Our perspective is they’re identical in terms of the Howey test that applies," said the SEC. "We think Coinbase is trying to create a different Howey test for when the people at this table might sell the tokens to each other on its platform and when Terraform might sell its tokens on Coinbase’s platform.
And we think that’s just wrong, your honor.”
Coinbase’s legal team argued that Terraform Labs’ case did not involve secondary market transactions, such as the ones conducted on the Coinbase platform. Another key difference appointed in court is that, in Terraform Labs' dispute, investors and the company were in a private relationship.
“But the Terraform case, first of all, as I know the court knows, did not involve secondary market transactions," they argued.
There were no secondary market transactions in that case. [...] Those were all situations where there was a relationship between the investor and the promoter.”
In addition, Coinbase counsel explored the legal requirements for establishing an investment contract under U.S. law, which requires a type of financial arrangement where an individual invests money in a venture managed by another party with the expectation of earning a profit.
"An investment contract, at a minimum, requires the contracting parties to agree or scheme together that the contractee will invest in the contractor’s profit-seeking endeavor.”
According to Coinbase, users trading tokens on its platform may or may not seek profit on the investment, as tokens can also be acquired for their utility. Judge Failla added that investors can purchase tokens because they are “cool” or because a friend owns them.
Ripple, stocks and more talks over secondary market transactions
Coinbase argued that token holders don't receive dividends or have legal rights over a project just because they own tokens, which is different from stocks.
"A stock reflects an interest in the permanent capital of a corporation. And when it trades, that interest in the permanent capital of the corporation, which is a participation in its capital structure, transferred in entirety from one holder to another holder."
The discussion over stocks and crypto tokens stemmed from Ripple’s ruling from July 2023, when Judge Analisa Torres granted a summary judgment in favor of Ripple Labs, determining that the XRP token is not a security when sold via programmatic sales on exchanges. However, Judge Torres also found that XRP was a security when sold to institutional investors, aligning with the criteria of the Howey Test.
Related: Coinbase refutes Senator Warren’s government insider allegations
"The critical takeaway there is that Judge Torres recognized that secondary market token purchases of XRP were not investing in Ripple. And in that sense, it rejected what I think is a core portion of the Commission's argument before the court today, which is its investment in an ecosystem, at least with respect to transactions between strangers, where no relationship exists, where no obligations travel."
In Coinbase's view, blind trades between individuals on its platform does not constitute an investment agreement.
The SEC sued Coinbase on June 6, 2023, alleging that the cryptocurrency exchange violated federal securities laws. The agency argued that 13 tokens listed on the exchange were securities, including coins like Solana (SOL), Cardano (ADA), Polygon (MATIC), Filecoin (FIL), The Sandbox (SAND), Axie Infinity (AXS), Chiliz (CHZ), Flow (FLOW), Internet Computer (ICP), NEAR (NEAR), Voyager (VGX), Dash (DASH) and Nexo (NEXO).
Magazine: Crypto regulation — Does SEC Chair Gary Gensler have the final say?
