Coinbase Files Motion to Compel Against CFTC in SEC Case

R Tamara de Silva

Coinbase has recently taken a significant legal step, filing a motion to compel the Commodity Futures Trading Commission (“CFTC”) to produce documents and communications with issuers of 12 tokens central to its ongoing lawsuit with the U.S. Securities and Exchange Commission (“SEC”). This motion highlights Coinbase’s defense against the SEC’s assertion that these tokens, traded on Coinbase’s platform, qualify as securities under the Howey Test.[1]

What is at Stake?

In June 2023, the SEC sued Coinbase, alleging that it operates as an unregistered securities exchange, an unregistered clearing agency and an unregistered broker. Central to the complaint is whether 12 of the 240 digital assets or tokens listed on Coinbase’s platform are “investment contracts,” making them securities subject to SEC oversight. Coinbase disputes this interpretation, arguing that the tokens do not meet the requirements of the Howey Test, a standard developed by the U.S. Supreme Court to determine what qualifies as a security.

Coinbase’s motion to compel asserts that the CFTC possesses critical communications with the issuers of these tokens, which could provide essential facts about their development, functionality, and use. Coinbase contends that these documents will help demonstrate that the tokens should not be classified as securities, undermining the SEC's claim.

The motion is focused on compelling the CFTC to comply with a subpoena for two primary categories of documents: (1) the communications the CFTC had with the issuers of the named tokens, and (2) documents concerning the agency’s position on the regulatory status of digital assets. Coinbase notes that the CFTC has yet to conduct any meaningful search for these documents and has provided no substantial justification for its refusal.

Key Points Raised in Coinbase’s Motion to Compel

1. No Applicable Privilege: Coinbase strongly argues that the CFTC’s claim of privilege over the requested communications is meritless. The motion highlights that the subpoena specifically seeks communications between the CFTC and third-party token issuers, which cannot be protected by privileges like attorney-client privilege or the deliberative process privilege. These communications are external and not confidential government discussions, making the CFTC’s invocation of privilege unfounded.


2. Failure to Substantiate Burden: Another point in Coinbase’s motion is the CFTC’s failure to substantiate its claim that complying with the subpoena would impose an undue burden. Coinbase contends that the CFTC has not even attempted to look to ascertain the volume of responsive materials or assess the actual burden of fulfilling the request. To mitigate any potential burden, Coinbase offered to cover the costs associated with the search and review, but the CFTC declined.


3. Relevance to the Howey Test: Coinbase stresses that the requested communications are crucial to its defense in the underlying SEC litigation, particularly in determining whether the tokens qualify as securities under the Howey Test. The motion states that these communications may provide essential information about the tokens’ development, use, and promotion factors that may be instrumental in determining whether they constitute “investment contracts.” This argument is bolstered by a ruling in the Southern District of New York, where Judge Failla compelled the SEC to produce similar communications.

 

Case Background

The SEC’s lawsuit charges that certain digital tokens traded on Coinbase's platform meet the definition of “securities” under U.S. securities law. According to the SEC, only registered exchanges can lawfully offer securities for public trading, and only licensed brokers are allowed to engage in related brokerage services. Coinbase, however, is neither registered as a securities exchange nor as a broker.

The SEC argues that by facilitating the trading of these tokens without the required registrations, Coinbase has been acting both as an unregistered securities exchange and an unregistered broker. The complaint alleges that Coinbase operates as an exchange by providing a platform that brings together multiple buyers and sellers, allowing them to place orders and execute trades. Moreover, Coinbase is accused of performing the functions of a broker by soliciting investors, managing customer funds, and charging transaction-based fees.

Additionally, the SEC claims that Coinbase has also acted as an unregistered clearing agency, holding customer assets in Coinbase-controlled wallets and processing transactions by crediting and debiting customer accounts. Under U.S. securities law, offering custody and trade settlement services for securities requires SEC registration as a clearing agency.

On March 27, 2024, Judge Katherine Polk Failla, in a highly anticipated ruling, mostly denied Coinbase’s motion for judgment on the pleadings. In an 84-page decision, the judge, taking the SEC’s factual allegations as true for purposes of the motion, found that the SEC had plausibly alleged that crypto-asset transactions on Coinbase’s platform involved investment contracts under the Howey Test. As such, the court ruled that Coinbase’s activities likely constituted securities transactions, allowing the SEC’s claims under the Securities Act of 1933 and the Securities Exchange Act of 1934 to proceed.

However, the court dismissed one portion of the SEC’s claims: regarding Coinbase’s Wallet application, Judge Failla found that the SEC had not plausibly alleged that Coinbase engaged in broker-dealer activity as defined under Section 15(a) of the Securities Exchange Act.

Judge Failla’s decision stands in contrast to the approach taken by the court in SEC v. Ripple.[2] In Ripple, Judge Analisa Torres in the context of a motion for summary judgment, distinguished between primary and secondary market transactions for the purposes of SEC jurisdiction, offering a narrower interpretation and finding that sale of XRP tokens on public exchanges did not constitute the sale of securities.

By contrast, Judge Failla’s ruling adopts a more expansive view of SEC oversight, considering a wide array of offers, communications, advertising, social media posts, and other circumstances “surrounding” crypto-asset transactions. This approach is reminiscent to the approach taken by Judge Jed S. Rakoff in SEC v. Terraform Labs Pte Ltd.[3] In ruling on a motion to dismiss, Judge Rakoff looked at marketing materials and social media posts among other factors, to conclude that investors were sold on the expectation of profits in the crypto assets based on the technical knowledge and efforts of the defendants.

Why These 12 Tokens?

While the SEC has not publicly explained why it chose these specific 12 tokens from the approximately 240 available on Coinbase, there maybe strategic reasons behind the selection. The SEC may have identified these tokens as having characteristics that most clearly meet the criteria of “securities” under the Howey Test, such as significant investor expectations of profits and reliance on the efforts of others to generate those profits. Focusing on a smaller subset of tokens also allows the SEC to build a more targeted and manageable case, which could set precedents applicable to other tokens in the future.

Other Precedents

Several court rulings provide context for how digital assets may be classified as securities:

• SEC v. Telegram Group Inc: The SEC prevented Telegram from distributing 2.9 billion ‘Grams’, a crypto asset, to 175 purchasers for $1.7 billion, arguing that it was an unregistered securities offering. The court ruled that this sale was part of a broader scheme to distribute the Grams into a secondary public market, thereby constituting a securities transaction.[4]
• 
  SEC v. Kik Interactive Inc: The SEC brought an enforcement action against Kik Interactive for its unregistered sale of crypto-assets. The court held that Kik's initial coin offering (ICO) constituted a securities offering under the Howey Test, rejecting the argument that ongoing contractual obligations were required for an investment contract.[5]

 

Coinbase’s Defense

In its response to the SEC’s complaint and its motion for judgment on the pleadings, Coinbase centers its defense on a fundamental argument: that the SEC does not have the authority to regulate its platform. Coinbase’s defense rests on two primary claims.

First, the company asserts that none of the digital assets available for trade on its platform qualify as securities. Second, Coinbase argues that the SEC’s enforcement action violates the major questions doctrine. This doctrine limits executive agencies, such as the SEC, from adopting new regulatory frameworks without clear congressional authorization. Coinbase contends that regulating its digital assets as securities represents a significant expansion of the SEC’s regulatory powers, which should be left to Congress.

However, this argument may face challenges, as seen in SEC v. Terraform Labs, where the court ruled that the SEC’s enforcement actions were not an overreach of its existing powers. The court ruled that applying the Howey Test to digital assets did not constitute the creation of new regulatory frameworks but rather the enforcement of existing law.

Potential Broader Regulatory Implications

The Coinbase case holds significant implications for the broader regulatory landscape of cryptocurrency in the United States. If the SEC prevails, it could lead to increased regulatory scrutiny for all crypto exchanges and digital asset platforms. These platforms may be forced to register as securities exchanges, brokers, or clearing agencies, depending on their activities. Such a ruling would impose significant compliance costs, requiring platforms to enhance their operations to meet stringent SEC requirements.

For example, crypto exchanges could face new obligations, including registering tokens as securities and implementing rigorous disclosures for both issuers and investors. This could increase legal, financial, and operational burdens, particularly on smaller crypto firms, driving some platforms to move operations outside the United States to avoid these regulatory requirements.

Moreover, additional enforcement actions may follow this case as the SEC seeks to solidify its oversight of the digital asset market. Platforms that do not comply with registration or disclosure requirements could face fines, trading halts, or even injunctions from operating. This would force many crypto businesses to reevaluate their token listings and trading mechanisms, with some potentially delisting tokens deemed high-risk under securities law.

These shifts could drive innovation in regulatory technology (“regtech”) solutions as businesses seek to automate compliance. However, they may stifle certain areas of crypto innovation as platforms move cautiously or abandon the U.S. market entirely, unsure of the evolving regulatory environment.