September 27, 2022

Volume XII, Number 270

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September 26, 2022

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Is Crypto a Security? Insider Trading Case Leads to DOJ, SEC Scrutiny

Just one month after bringing the first ever insider trading case involving NFTs, the U.S. Attorney’s Office for the Southern District of New York has charged three men in an alleged insider trading scheme involving cryptocurrency. This is the first case in which prosecutors have alleged insider trading of cryptocurrencies. At the same time as the DOJ’s announcement of criminal charges, the SEC filed a companion civil case in Seattle federal court alleging that the three men engaged in insider trading and arguing that some of the assets involved were “securities” under federal securities law. 

These two cases suggest a more aggressive stance by federal authorities towards fraud involving cryptocurrency and crypto assets trading platforms in the U.S.

In an indictment unsealed on July 21, 2022, a former Coinbase Global, Inc. product manager, Ishan Wahi, was charged with tipping off his brother and a close friend with confidential business information he learned regarding crypto assets that were listed or under consideration for listing on Coinbase. Specifically, federal prosecutors alleged that as a manager at Coinbase, Wahi had access to detailed and advanced knowledge of which crypto assets Coinbase was planning to list and the timing of public announcements about those listings.

This information was considered highly confidential within Coinbase since the market value of crypto assets would ordinarily increase after Coinbase announced that it would be listing a particular asset on its exchanges. Despite numerous internal policies designed to protect this information from dissemination, Wahi allegedly misappropriated and disclosed it to his brother and his friend so that they could make well-timed purchases of crypto assets in advance of Coinbase’s listing announcements. According to the indictment, Wahi’s brother and friend purchased at least 25 crypto assets in advance of at least 14 separate Coinbase crypto asset listing announcements, generating approximately $1.5 million in returns.

The three defendants were ultimately charged with four counts of wire fraud resulting from their insider trading scheme.

In a parallel civil action, the SEC did file securities fraud charges against the three defendants involved in the Coinbase insider trading scheme. While the basic facts of the SEC’s complaint mirrored the charges from the criminal indictment, the SEC alleged that that at least nine of the Coinbase listing announcements involved “crypto asset securities . . . subject to the federal securities laws.” The SEC maintained these crypto assets were “securities” since they were “investment contracts; they were offered and sold to investors who had made an investment of money in a common enterprise, with a reasonable expectation of profits to be derived from the efforts of others.”

Unlike a typical insider trading case, however, federal prosecutors did not bring securities fraud charges against the defendants and made no substantive allegations that any of the defendants traded in securities as part of their scheme. The SEC’s efforts to characterize these assets as securities will be critical in its attempt to successfully charge Wahi and his co-defendants with insider trading. Unlike the DOJ action, which relies upon a more traditional wire fraud claim of theft of confidential business information, the SEC must first establish that the crypto assets at issue are in fact securities before it can get to the next step of establishing the defendants engaged in securities fraud.

The classification of these crypto assets as securities is a controversial position, as many cryptocurrency exchanges have taken the position that the assets on their exchanges are not securities and cannot be regulated like stocks or bonds. Coinbase objected to the SEC’s characterization of the assets as securities and insisted that “[n]o assets listed on our platform are securities.” The SEC’s classification also drew criticism from Caroline D. Pham, a commissioner with the Commodity Futures Trading Commission, who wrote on Twitter that the SEC’s complaint “was a striking example of ‛regulation by enforcement.’” She went on to note that the SEC’s decision to pursue securities fraud charges in this case had broader implications for the crypto industry and the appropriate regulatory framework.

These insider trading cases demonstrate the enforcement priority prosecutors and regulators are putting on crypto assets and exchanges. Indeed, federal prosecutors have been clear that they will not be deterred from aggressively pursuing fraud charges involving digital assets. “Fraud is fraud is fraud, whether it occurs on the blockchain or on Wall Street,” said Damian Williams, the U.S. Attorney for the Southern District of New York, in a DOJ press release.

It is reasonable to expect that these recent cases are just the beginning of an enforcement crackdown on illegal conduct in the crypto environment. Both the DOJ and SEC have been putting increased resources into understanding crypto markets and learning how to apply their enforcement tools to those markets. Accordingly, we should expect to see an increase in enforcement cases involving the NFT and cryptocurrency markets.

© 2022 BARNES & THORNBURG LLPNational Law Review, Volume XII, Number 208
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About this Author

Eric H. Sussman Illinois Partner Barnes & Thornburg LLP
Partner

Eric Sussman is a former federal prosecutor who focuses his practice on white collar criminal defense, securities enforcement matters, internal investigations, and complex commercial litigation. He is a highly accomplished trial lawyer who has defended numerous sophisticated civil and white collar criminal matters for corporations and executives in courts throughout the United States.

Having tried over 35 federal and state cases, briefed and argued many cases before the U.S. Court of Appeals for the Seventh Circuit, handled arbitration...

312-214-4599
David Slovick Securities and Corporate Financial Attorney Barnes & Thornburg Law Firm
Partner

David regularly represents financial services firms and individuals in investigations and litigation conducted by the CFTC, the SEC, the Financial Industry Regulatory Authority, CME Group, and other regulatory agencies and organizations. His experience covers the spectrum of enforcement and regulatory matters, including derivatives and securities trade practices, disclosure fraud, insider trading, market manipulation, issuer statutory disqualification, and derivatives and securities regulatory compliance. 

David served for nearly a decade at the...

646-746-2019
Katerina Katie Mills Finance Attorney Barnes and Thornburg Los Angeles
Associate

Katerina (Katie) Mills assists with a range of financial services and digital asset regulatory matters, transactions, compliance, and licensure. Knowledgeable and driven, Katie works collaboratively with her colleagues and clients to find flexible and comprehensive solutions to meet clients’ needs.

She advises on day-to-day compliance issues, anti-money laundering and financial institution regulatory matters, payment products and cryptocurrency regulations, and issues involving financial technology products. She also as a deep understanding of...

310-284-3830
 Vincent P. Trace Schmeltz III, Barnes Thornburg Law Firm, Chicago and Washington DC, Corporate and Litigation Law Attorney
Partner

Trace Schmeltz is a partner in the Chicago office of Barnes & Thornburg LLP, where he is the co-chair of the firm’s Financial, Corporate Governance, and M&A Litigation Group and a member of the White Collar Crime Defense Practice Group. A trial attorney with experience in numerous forums including the Delaware Court of Chancery, he concentrates his practice on securities, commodities, mergers and acquisitions and white collar criminal litigation. In addition, he has pursued and defended claims on behalf of auditors, investment banks, corporate boards and corporations....

312-214-4830
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