September 26, 2022

Volume XII, Number 269


September 23, 2022

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Concerning Questions Raised by SEC Action Against Former Coinbase Employee

On July 21, 2022, the Department of Justice (DOJ) and the US Securities and Exchange Commission (SEC) each alleged insider trading violations against a former Coinbase employee, his brother, and another alleged acquaintance of his. Coinbase is one of the leading exchanges in the United States for the trading of cryptocurrencies. The DOJ brought charges of wire fraud against the three defendants in the Southern District of New York without any allegations of securities law violations, while the SEC brought a civil claim for insider trading in violation of Section 10(b) of the Securities Exchange Act of 1934 [15 U.S.C. § 78j(b)] and Rule 10b-5 thereunder in the Western District of Washington against the same three defendants.

The SEC action raises questions about the state of digital asset regulation in the United States and could hamper digital asset development in the United States if there are not changes to this “regulation by enforcement” strategy by the SEC.  

The Case as Presented by the SEC/DOJ and the DOJ Indictment:

The factual allegations by both the SEC and DOJ cases are largely the same. According to the DOJ Indictment and SEC Complaint (available here and here), Ishan Wahi (“Ishan”), is a former Coinbase product manager assigned in the asset listing team. In that role, Ishan “was involved in the highly confidential process of listing crypto assets on Coinbase’s exchange” DOJ Indictment, ¶2. Coinbase has numerous requirements before it will allow a digital asset to be listed for trading, including that it does not list tokens which it considers to be securities under US federal securities laws. Due to the rigorous criteria for listing a digital token on Coinbase, typically the market price of the token increases once there has been a public announcement that the token will be listed. As such, advance knowledge that Coinbase will approve a token for listing could be used to purchase the token at a potentially unfair discount. Id.

Ishan allegedly took his advance knowledge of Coinbase’s asset listings and informed his brother Nikhil Wahi (“Nikhil”) and former college roommate Sameer Ramani (“Sameer”) of those upcoming listings. This allowed Nikhil and Sameer to buy those assets ahead of the listings and realize at least $1.5 million in combined gains after those assets had predictable bumps in value after being announced for listing on one of the largest cryptocurrency exchanges in the world. DOJ Indictment, ¶3.

The scheme appears to have been detected by Coinbase. On May 11, 2022, Coinbase’s director of security operations reached out to Ishan to schedule a meeting regarding a suspected breach in confidentiality which resulted in assets being heavily traded ahead of Coinbase’s listing announcements. This increase in trading was also deduced in the market and discussed on Twitter, in large part due to Twitter influencer @Cobie tweeting about suspicious trading activity. The Cobie tweet is cited in the DOJ’s indictment. DOJ Indictment, ¶15.

Possibly to avoid appearing for the interview with Coinbase’s director of security, Ishan purchased a one-way plane ticket to India and sent emails to his friends and colleagues explaining he had to go home for a family issue. DOJ Indictment, ¶18. However, this attempt to flee was thwarted when Ishan was apprehended by authorities and prevented from leaving the United States. According to the indictment, when apprehended Ishan had in his possession “an extensive array of belongings, including, among other items, three large suitcases, seven electronic devices, two passports, multiple other forms of identification, hundreds of dollars in U.S. currency, financial documents, and other personal effects and items.” DOJ Indictment, ¶20.

While Ishan and Nikhil were arrested and will face charges with a possible penalty of 20 years of incarceration, Sameer is still at large and believed to be in India, having departed the US shortly after being informed by Ishan of the internal Coinbase investigation. SEC Complaint, ¶16.

The DOJ charges alone are certainly newsworthy with similarities to the DOJ allegations against former OpenSea executive Nate Chastain (which we covered on the BitBlog here). Viewed in a bubble, the DOJ action appears to demonstrate effective compliance, enforcement, and collaboration among government, industry leaders, and social media activists as the combined investigative efforts of all three parties led to the perpetrators being brought to justice. Indeed, it was the public nature of the blockchain which allowed individuals on social media to bring these suspicious transactions to light.  Coinbase also cooperated with the DOJ’s investigation. 

The DOJ action shows how fraudsters can be apprehended under existing laws without an expansion of the securities laws. While the DOJ uses “insider trading” language in its press release, the charges are brought under the federal wire fraud act (18 U.S.C. § 1343) for Ishan’s alleged breach of his confidentiality agreement with Coinbase and Nikhil/Sameer’s use of that confidential information.

Charges in the SEC Civil Action:

When the DOJ indicts defendants on criminal charges of insider trading, it is not uncommon for the SEC to also bring a parallel civil action which typically gets stayed during the pendency of the criminal action.  This matter is unusual, however, because the DOJ alleged insider trading under traditional wire fraud laws rather than under securities laws.  Still, the SEC decided to file a civil complaint for securities insider trading against the same parties.  Because the charges being brought by the SEC are not identical, and there are major questions of law (such as whether the tokens are securities) that are unlikely to be addressed in the DOJ matter, it is unclear whether these proceedings will stay during the DOJ prosecution.

Coinbase has repeatedly taken the position that none of the coins it lists are securities. For example, in Coinbase’s written testimony for the Congressional Subcommittee on Capital Markets, Securities, and Investment, they stated:

“To help potential market participants, we published our Digital Asset Framework to provide transparency about how we consider listing new assets. A key factor in our framework analysis is a determination that the potential new asset is not a security under U.S. law. The absence of regulatory clarity has slowed our willingness and ability to list new assets.” (Full written testimony available here).

However, the SEC has affirmatively alleged that at least nine of the 25 tokens traded by the defendants ahead of their Coinbase listings are “crypto asset securities,” the trading of which on non-public information constitutes a violation of Section 10(b) of the Exchange Act [15 U.S.C. § 78j(b)] and Rule 10b-5 thereunder. The nine assets alleged to be crypto asset securities by the SEC are $AMP, $RLY, $DDX, $XYO, $RGT, $LCX, $POWR, $DFX, and $KROM. SEC Complaint, ¶¶ 39, 45, 50, 57, 71, 78, and 82.  While neither the SEC nor DOJ has released the full list of assets traded by Ishan, Nikhil, and Sameer, we do know by comparing the DOJ’s indictment to the SEC’s Complaint that $TRIBE, $ALCX, $GALA, and $ENS are all coins traded by the indicted individuals but not alleged to be securities in the SEC Complaint.

Following the filing of the SEC Complaint, Coinbase continued to state that these tokens are not securities by issuing a statement from their Chief Legal Officer (and former Magistrate Judge for the Northern District of California) Paul Grewal titled “Coinbase does not list securities. End of story.” (available here). The SEC did not charge Coinbase with trading in securities which Coinbase would not be allowed to do without becoming an SEC registered exchange. The SEC failed to charge any of the 9 token issuers that it alleges are securities with violations of the securities laws.

Implications and Ramifications:

Bringing this action was an interesting strategic decision by the SEC.  Rather than bringing an action against Coinbase, a large public company with nearly unlimited resources to defend a regulatory action, or even against the token issuers, the SEC is bringing this claim against three individuals who are facing criminal charges, one of whom likely won’t defend himself at all because he is still on the lam.  Because these defendants have limited resources and probably are more interested in staying out of prison than being punished by the SEC, it is unlikely that they would challenge the SEC’s characterization of the tokens as securities.  While Coinbase could try to join the case by interpleader, it is unlikely that they could have much influence on the civil action.

Many, including Coinbase, feel that the SEC would be fulfilling its duty of protecting consumers by setting up a framework for what is and is not considered a security in the digital asset space. On July 21, Coinbase issued an additional statement which “calls on the SEC to develop a workable regulatory framework for digital asset securities guided by formal procedures and a public notice-and-comment process, rather than through arbitrary enforcement or guidance developed behind closed doors.” (Full statement available here).  Coinbase has stated that the timing of this statement was incidental and that they had planned on making this statement even when they had no knowledge that the SEC would bring a civil claim in the case.

The SEC action here has even raised a rare public rebuke from another government regulatory body.  CFTC Commissioner Caroline Pham issued a statement on the SEC case, describing it as “a striking example of regulation by enforcement.” (Full statement available here).  Separately, according to Bloomberg, it has been leaked that Coinbase is also the subject of an SEC investigation on whether it has been improperly listing unregistered securities.  In the wake of the XRP action that has dragged on since late 2020 in which the SEC has lost a number of prominent motions, this action could be used to create a “precedent” where there is no meaningful voice opposing the SEC’s theories.   

The crypto industry needs meaningful regulatory guidance. As these cases indicate, fraud is a real problem, but this particular action does not appear to have any meaningful deterrent effect, given the DOJ’s case which does not involve allegations regarding securities.  The stated mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.  This can only be accomplished in the crypto space once the market understands what is or is not a security and there is a workable path to compliance.  

© Polsinelli PC, Polsinelli LLP in CaliforniaNational Law Review, Volume XII, Number 217

About this Author

Stephen A. Rutenberg Shareholder Polsinelli New York Bankruptcy and Financial Restructuring Bankruptcy Litigation Capital Markets ,Commercial Lending ,Debt and Claims Trading, Financial Services, Insolvency, Financial Technology FinTech and Regulation

Stephen Rutenberg’s practice focuses on the intersection of special situations investing and FinTech including cryptocurrency and blockchain technology. 

A significant component of Stephen’s practice relates to his work in the distressed debt market, representing clients in the purchase and sale of loans and securities of distressed and bankrupt companies. Recent representations include advising on the purchase, sale and financing of bankruptcy trade claims in several major chapter 11 cases, including Lehman Brothers, and the MF Global and Icelandic bank liquidations. He works with...

Daniel L. McAvoy Shareholder Investment Funds Securities & Corporate Finance Mergers, Acquisitions and Divestitures Corporate and Transactional Joint Ventures and Strategic Alliances

Dan McAvoy focuses his practice on private closed-end investment funds, corporate finance and M&A with a focus on private investment fund transactions, including complex GP-led restructurings and secondary transactions. Dan is a trusted adviser to numerous investment advisers, fund sponsors and investors, and has represented a range of companies, from startups to Fortune 500 companies. Dan has also represented portfolio companies and sponsors through all parts of the corporate life cycle, including formation, venture financings, add-ons, stock sales, asset sales, private and...


Jonathan Schmalfeld is an Associate with Polsinelli's St. Louis office. He is committed to understanding how privacy, data security and technology impact each client’s business model, practices, and objectives to help protect their investment in various technologies. He negotiates complex technology and related transactions for clients across a variety of industries. Jonathan’s practice focuses on advising clients in privacy and data security matters, including both litigation and counseling on compliance with domestic and international privacy and data security laws and regulations.