On July 21, 2022, the US Securities and Exchange Commission (SEC) filed a civil enforcement action alleging that from at least June 2021 to April 2022, the three named defendants orchestrated and perpetrated an insider trading scheme amassing over $1.1 million in illicit gains from crypto asset trading. The action alleges that Ishan Wahi, who was formerly employed by Coinbase as a product manager, tipped off Nikhil Wahi and Sameer Ramani with non-public information regarding certain crypto assets that had been approved for listing on Coinbase. This information allowed Wahi and Ramani to purchase said crypto assets and profit after the listings were publicly announced. The US Department of Justice (DOJ) also brought a criminal indictment, charging wire fraud conspiracy and wire fraud in connection with the scheme. Most notably, the SEC’s enforcement action is premised on allegations that “at least nine” of the 25 crypto assets purchased and sold throughout the alleged scheme are securities.
In that regard, this case differentiates itself from the DOJ’s recent indictment of former OpenSea Product Manager Nathanial Chastain. Despite the DOJ’s use of the phrase “insider trading” in its indictment of Chastain, the SEC declined to charge him or allege that the non-fungible tokens (NFTs) involved are securities. In contrast, in SEC v. Wahi, the SEC formally charged the defendants with having violated the federal securities laws, specifically the antifraud provisions of section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder.
Although SEC insider trading cases are not uncommon, this SEC enforcement action is the first where the security is a crypto asset. As a result, the outcome of SEC v. Wahi may have far-reaching consequences with regard to cementing the SEC’s authority to regulate the crypto asset industry. Further, this action may be the spark that ignites a wave of SEC enforcement actions against other players in the industry.
SEC ALLEGATIONS OF CRYPTO ASSET SECURITIES
While the SEC noted that the defendants’ scheme involved at least 25 crypto assets, the SEC’s complaint identifies only nine crypto assets that are alleged to constitute securities. As with prior SEC enforcement actions involving crypto assets, the SEC’s securities analysis of these nine crypto assets is based on the definition of “investment contract” as articulated by the Supreme Court of the United States in Securities & Exchange Commission v. W.J. Howey Co.¸ 328 U.S. 293 (1946) (Howey Test). Under the Howey Test, investment contracts involve an investment of money in a common enterprise with a reasonable expectation of profits derived from the efforts of others. For each of the nine crypto assets cited by the SEC, the complaint sets forth the purported basis for a common enterprise and delves into why there was a reasonable expectation of profits based on the efforts of others. In other words, the SEC’s complaint provides a roadmap of the facts it has examined in determining whether each crypto asset is a security, including: (1) a company’s public statements regarding the potential for crypto asset purchasers to realize profits; (2) the involvement of management teams in the ongoing success of the crypto asset and (3) efforts to promote the utilization of secondary market platforms.
To demonstrate the presence of a “common enterprise” within the meaning of the Howey Test, the SEC emphasized that the founders and executives who launched these crypto assets designed its ecosystem, through staking incentives or otherwise, such that purchasers would collectively benefit from profits generated by said ecosystem. The SEC also cited to statements by the founders that funds raised from the sales of these crypto assets would be pooled and used to develop the network for the common benefit of the purchasers and future holders of the crypto assets. Further, the SEC claimed that the fact that the founders and executives themselves held large amounts of the crypto assets suggested that the economic incentives of insiders and public purchasers of the crypto assets were aligned.
In alleging that purchasers of these crypto assets held a “reasonable expectation of profits based on the efforts of others,” the SEC referred to statements made by the founders and company executives promoting the crypto assets to purchasers based on the potential to earn profits. These statements included excerpts from white papers, company websites, social media posts and other public statements that reference the investment potential, past performance or future demand for, or scarcity of, the crypto asset. The SEC also noted efforts by such persons to create a secondary market for said crypto assets, including through listings on exchanges. Finally, the SEC noted marketing materials and other public statements that included the work histories of the founders and management team, touting their expertise and credentials. The SEC claimed that these statements created an implied reliance that such executives would perform critical roles in increasing the value of the crypto assets.
THE PUBLIC’S RESPONSE TO SEC ALLEGATIONS
Many have viewed the SEC’s actions in this case as notice that other crypto assets, including those that are listed popular exchanges, may be deemed to be, or determined to be, securities. Coinbase responded to the action by stating that it disagrees with this conclusion. Coinbase also implicitly called to question the forum in which this debate is being brought, from a position of enforcement rather than one of guidance and rulemaking: “Coinbase has a rigorous process to analyze and review each digital asset before making it available on our exchange—a process that the SEC itself has reviewed. This process includes an analysis of whether the asset could be considered to be a security[.]”
On the same day that the Wahi action was filed, Coinbase also submitted a petition for rulemaking to the SEC, requesting additional regulations that would bridge the shifting paradigm from centralized exchanges to distributed ledger technologies, including rules that would clarify the process for identifying when a crypto asset is a security. Other private sector actors have responded to Wahi by distancing themselves from the underlying allegations, with some exchanges proactively delisting the nine crypto assets identified by the SEC as securities.
Other regulators of the crypto asset industry also had strong responses to the SEC bringing an enforcement action under these circumstances. In a public statement, Commodity Futures Trading Commission (CFTC) Commissioner Caroline D. Pham expressed concern with the SEC’s approach, characterizing it as “a striking example of ‘regulation by enforcement’” and claiming that the “SEC’s allegations could have broad implications beyond this single case, underscoring how critical and urgent it is that regulators work together.” Similar to Coinbase, Commissioner Pham advocated for rulemaking initiatives, which would benefit from a public notice-and-comment process, rather than enforcement.
The enforcement action brought by the SEC in SEC v. Wahi marks a novel and perhaps monumental public moment in the debate over crypto assets and their potential categorization as securities. The outcome of this most recent SEC enforcement action will not only provide additional color as to the SEC’s assessment of crypto assets vis-à-vis the securities laws but may be a prelude to additional crypto asset enforcement actions to come. It should not be lost on the industry that Wahi comes in the direct wake of the SEC’s hiring of more than 50 staff members for its newly minted Crypto Assets and Cyber Unit. At the very least, Wahi marks a notable push for the SEC to reach SEC Chairman Gary Gensler’s stated goal of meeting the expectations of the public to “police wrongdoing in the crypto market.”
Wahi also reignites an ongoing question as to which regulator should have enforcement authority over the crypto asset industry. For example, earlier this year CFTC Chairman Rostin Benham publicly reiterated the need for the CFTC to have additional authority to regulate crypto assets. In comparison, Chairman Gensler has publicly stated that when crypto assets functionally operate as securities, just like with any other security, it remains the SEC’s prerogative to develop “robust ways to protect investors.” In a public tweet, Chairman Gensler further provided that “[t]here is no reason to treat the crypto market differently just because a different technology is used.” Under the recently proposed Financial Innovation Act, a bipartisan effort from Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY), attempts to group crypto assets into categories based on the unique characteristics of the particular crypto asset. Industry participants have sought clarity on the classification of crypto assets by regulation rather than enforcement actions. For now, market participants are left to attempt to interpret the actions by the SEC and how (and whether) they apply to other crypto assets.
 Mengqi Sun, CFTC Signals Intent to Increase Enforcement of Crypto-Related Cases, The Wall Street Journal (May 18, 2022), https://www.wsj.com/articles/cftc-signals-intent-to-increase-enforcement-of-crypto-related-cases-11652908480.
See Speech, “Prepared Remarks of Gary Gensler on Crypto Markets Penn Law Capital Markets Assocation Annual Conference,” (April 4, 2022) (available at: https://www.sec.gov/news/speech/gensler-remarks-crypto-markets-040422).
See Gary Gensler, Tweet (available at: https://twitter.com/GaryGensler/status/1552700562533236739).