Coinbase Has a ‘Good Shot’ of Defeating the SEC in Court, Says Consensys Lawyer
The critical ruling could determine the legality of digital asset sales on secondary markets
By: André Beganski
January 19, 2024
Coinbase’s legal battle with the Securities and Exchange Commission isn’t just a threat to America’s leading crypto exchange. The lawsuit’s outcome could have major consequences for other crypto firms too, according to Bill Hughes, senior counsel and director of global regulatory matters at MetaMask maker Consensys.
“It's really important for everyone that the court gets it right,” he told Coinage in a Friday interview. “The [case's] outcome will implicitly dictate what is inbounds and what is not for crypto, at least in the United States."
Accused of flaunting securities laws before it offered its customers staking and trading, Coinbase was sued by the SEC last June. Calling components of Coinbase’s business — like its self-custodial wallet product into question — the regulator also highlighted 13 tokens, including Solana and Polygon, as examples of securities that trade on Coinbase’s platform.
Hughes said Judge Katherine Polk Failla appeared sympathetic to some of Coinbase's arguments as the SEC battled back and forth for hours during the Manhattan courtroom hearing. At the same time, Hughes posited that Judge Failla will likely dismiss some elements of the SEC's case but let others progress.
“It looks like Coinbase has a pretty good shot at getting an answer that would not only be good for Coinbase but the entire industry,” he said. “I think it's more likely than not she will decide some issues, but not all issues.”
If Judge Failla decides to toss out any part of the SEC’s lawsuit, Hughes reckoned the regulator’s qualms with Coinbase’s staking services, which allow users to earn a yield on certain cryptocurrencies deposited, are most likely to go. Describing it as the weakest part of the SEC’s case, he said Failla appeared suspect of the SEC’s stance in court on Wednesday.
“The ecosystem views [staking] as providing technical services on the part of Coinbase,” he said. “Just like when you run this podcast, … you likely don't have your own servers anymore. You likely farm that out to AWS or someone else.”
And even if Judge Failla opts to preserve parts of the SEC’s case when deciding on Coinbase’s motion, it doesn’t necessarily mean the judge is sympathetic toward the regulator’s arguments, Hughes said. It could just indicate that Judge Failla doesn’t have enough in the case’s record to rule on the issue yet.
Coinbase’s reading of Howey is faithful to its text and has cognizable limits. The SEC’s does not have limits, no matter how hard the staff tries to suggest otherwise. https://t.co/4BCvJ0Tzfz— Bill Hughes : wchughes.eth 🦊 (@BillHughesDC) January 17, 2024
In terms of how Coinbase’s legal tussle could break new ground in crypto-centric case law, Hughes said it's the first time the so-called Howey Test has been applied to secondary sales of an asset. The Supreme Court framework, established in 1946, has historically been applied to the issuers of assets themselves, he said.
“You didn't issue [the tokens]. You're not promoting them. You, [a] third party are merely offering a mechanism for people to buy and sell them,” he said. “This is important because the Howey Test is really only applied [to] issuers.”
Decisions from other judges in the Southern District of New York could influence Failla’s decision-making, but Hughes argued that a recent ruling from Judge Jed Rakoff in the SEC’s case against Terraform Labs, which found Terra and Luna tokens to be securities, creates a standard for identifying schemes attached to investment contracts that is too broad.
“My problem with Rakoff's approach is … that case doesn't create any sort of guidelines for how broadly you can look for facts that constitute a scheme,” he said. “[Failla] is very troubled that this way of looking at the issue doesn't have any meaningful limiting principle as to what, in this context, could be considered an investment contract.”
One of the concerns expressed by Failla on Wednesday was the prospect of collectibles like Beanie Babies or baseball cards falling into the SEC’s regulatory domain. From Hughes’ perspective, the SEC’s assurances that collectibles aren’t subject to securities laws are problematic.
“They give this sort of limp-wristed assurance like, ‘Well, we're not interested in that, so that's not really a problem,” he said. “Well, it is a problem when you just get to pick and choose what collectibles and what commodities … you're going to regulate.”
While Judge Rakoff’s decision in the SEC’s case against Terraform Labs could bear some influence on Coinbase’s chances of shaking off the SEC in court, Failla isn’t bound to abide by her peer’s logic, Hughes pointed out. So, where the case goes is truly up to her.
“Nobody has to follow the lead of any other judge at this level,” Hughes said. “They can look at other opinions that other judges issue, and they can … decide, ‘Does this persuade me to think a certain way?’”
Judge Failla is expected to deliver her ruling in the coming weeks.