SEC Investigates Possible Brokerage Activities Linked to Token Listings

Financial Services Law

Following the recent filing of the SEC’s insider trading complaint against a former manager of Coinbase Global, Inc. (“Coinbase”), the SEC is now investigating Coinbase. As stated in Coinbase’s Form 10-Q quarterly report filed on August 9, 2022, Coinbase “has received investigative subpoenas and requests from the SEC for documents and information about certain customer programs, operations, and existing and intended future products, including [Coinbase’s] processes for listing assets, the classification of certain listed assets, [Coinbase’s] staking programs, and [Coinbase’s] stable coin and yield generating products.” The SEC investigation is in addition to an examination of Coinbase’s subsidiary, Coinbase, Inc., by the New York Department of Financial Services, regarding the subsidiary’s compliance with anti-money-laundering provisions of the Bank Secrecy Act and sanctions laws, cybersecurity, and customer support. The quarterly report makes investors and the public aware of the potential consequences and risks of the investigations and discloses that “the ultimate resolution of one or more of these matters may have a material adverse effect on [Coinbase’s] results of operations” and that future changes in circumstances or additional information “could adversely affect [Coinbase’s] results of operations, potentially materially.”

Aside from determining more conclusively whether the digital assets, tokens and cryptocurrencies listed on Coinbase are “crypto asset securities,” as asserted in SEC v. Ishan Wahi, Nikhil Wahi, and Sameer Ramani (“Wahi”), the SEC’s investigation may focus on whether, as a result of listing securities, Coinbase is acting as an unlicensed broker-dealer and therefore required to register and comply with SEC regulations applicable to broker-dealers. Under Section 15 of the Securities Exchange Act of 1934 (the “Act”), broker-dealers must register with the SEC before selling securities. Section 3(a)(4)(A) of the Act defines a “broker” as any person or entity engaged in the business of effecting transactions in securities for the accounts of others. Based on the SEC’s allegations in Wahi, the SEC may take the position that Coinbase is acting as a broker when Coinbase effects trades in what the SEC refers to in Wahi as “crypto asset securities.” Through the SEC’s lens, Coinbase may be in violation of federal securities laws by providing an exchange platform without being a registered broker-dealer.

The SEC’s Guide to Broker-Dealer Registration states that entities that “operate or control electronic or other platforms to trade securities” and that “effect or facilitate securities transactions” or “handle the securities or funds of others in connection with securities transactions” are entities generally required to register as a broker.

Section 3(a)(5)(A) of the Act defines a “dealer” to mean any person or entity engaged in the business of buying and selling securities for their own account, through a broker or otherwise. The SEC states that “a firm that advertises publicly that it makes a market in securities is obviously a dealer,” and that businesses that buy and sell securities, or quote prices for purchases and sales of one or more securities, may require registration as a dealer.

In the event the SEC determines Coinbase is acting as a broker or dealer, the SEC could file a complaint requesting an injunction, potentially requiring Coinbase to cease all operations until properly registering under Section 15(b) of the Act.

Broker-dealer registration requirements include (i) filing Form BD with and receiving a grant of registration from the SEC; (ii) becoming a member of a self-regulatory organization (e.g., FINRA, or, potentially in the future, the Virtual Commodity Association); (iii) becoming a member of the Securities Investor Protection Corporation; (iv) complying with all applicable state requirements; and (v) ensuring all “associated persons” of the broker-dealer (defined to mean any partner, officer, director, branch manager or employee of the broker-dealer, any person performing similar functions, or any person controlling, controlled by or under common control with, the broker-dealer) satisfy all qualification requirements.

After successfully registering as a broker-dealer, the entity must ensure ongoing compliance with SEC regulations and reporting requirements. Antifraud provisions of federal securities laws, which prohibit misstatements or misleading omissions of material facts and fraudulent or manipulative acts and practices in connection with the purchase and sale of securities, along with the duty of fair dealing owed to customers, are among the many promulgations applicable to broker-dealers. Broker-dealers must also monitor and regulate various restriction periods applicable to securities offered and sold by the broker-dealer and implement internal training, trading restrictions and compliance policies to control material nonpublic information and prevent insider trading.

An additional regulation potentially applicable to Coinbase and other centralized or decentralized exchanges of digital assets is Section 3(a)(1) of the Act, which defines an “exchange” as any entity that “constitutes, maintains, or provides a market place for bringing together purchasers and sellers of securities.” Section 5 of the Act makes it unlawful for any broker, dealer or exchange to directly or indirectly effect any transaction in a security unless the exchange is registered on a national exchange or exempted from such registration. Regulation ATS (17 C.F.R. 242.300 et seq.) is an exemption that allows broker-dealer platforms to receive and execute electronic trades in securities without registering as a national securities exchange under Section 6 of the Act. Under Regulation ATS, an alternative trading system is defined as any entity that provides a marketplace for bringing together purchasers and sellers of securities or otherwise performing functions of a stock exchange. Subject to certain rules and restrictions, an entity registered as a broker-dealer may be exempted from registration as an exchange if such entity submits Form ATS, including an operation report, records and information relating to the entity’s trading system, and files quarterly reports with the Division of Trading and Markets, among other requirements.

Depending on the results of the SEC’s investigation of Coinbase and the judicial outcome in Wahi, greater judicial and regulatory understanding for the Web3 community and digital asset creators, investors and intermediaries may be on the horizon. If the SEC does conclude that more tokens are securities, it could have a chilling effect on exchanges that have managed to avoid broker-dealer regulations to date. 


Manatt Phelps & Phillips, LLP, is a globally recognized law firm with top attorneys in the blockchain, cryptocurrency, NFT, digital asset and fintech practice areas. We provide timely expertise to clients and practical guidance on state, federal and international regulations to ensure compliance while promoting innovation and cutting-edge momentum across industries. Our clients include fintech companies, creators and issuers of tokens, blockchain intermediaries, layer 2 platform developers, DAOs, and Web3 leaders.

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