Any day now, a US judge is expected to rule on whether the most important legal case in crypto history will go to trial or be dismissed.
Coinbase, the top crypto exchange in the US, has asked Judge Katherine Polk Failla to jettison all or at least part of the lawsuit brought last year by US Securities and Exchange Commission.
Coinbase Chief Legal Officer Paul Grewal expects to lose this skirmish.
“Judges generally don’t like to deprive any plaintiff of their full opportunity to prove their case — and that’s especially true when the US government is the plaintiff,” he told DL News in an interview.
“Our odds, even before we get out of the gate, are pretty low of getting this thing dismissed early.”
But it may not matter in the long run.
The SEC’s bad run
For all its authority, the SEC has been losing one legal battle after another in its effort to rein in the crypto industry.
In August, a federal appeals court ruled the agency was wrong to deny Grayscale Investments’ application to convert its Bitcoin trust into an exchange-traded fund.
This was huge. In January, Gary Gensler, the SEC’s hard-charging chair, conceded the ruling cleared the way for approval of Bitcoin ETFs sought by BlackRock, Fidelity Investments, and other asset managers.
No development has done more to make Bitcoin and its ilk a mainstream asset class.
The SEC also took a beating in the Ripple Labs case.
In October, the SEC grudgingly dropped allegations against two top executives at Ripple Labs after a federal judge ruled the agency partially erred by contending the company unlawfully failed to register the XRP token as a security.
The SEC did not respond to a request for comment from DL News.
Thick of the action
Now Gensler’s credibility on the one hand and the future of the US crypto industry on the other are riding on the outcome of the case before Judge Failla.
Grewal, a former US magistrate who knows something about judging litigation, is in the thick of the action.
By charging Coinbase with unlawfully letting investors trade unregistered securities — digital assets — the SEC is attempting to force the industry to comply with 90-year-old laws that govern stocks and bonds and any other “investment contracts.”
Coinbase counters that cryptocurrencies cannot be treated, in legal terms, the same as traditional securities.
The company has argued that blockchain-based assets deserve to be governed by their own tailor-made rules.
That means passing a new law or two. While Coinbase and the industry have won over some lawmakers on Capitol Hill, Congress has yet to move forward with a bill that would enshrine cryptocurrencies in their own statutory regime.
‘We have a fancy legal term of art to describe that phenomenon — they were talking out both sides of their mouth.’
Paul Grewal, Coinbase
So it will fall to the courts to decide whether the industry must comply with the same laws the rest of Wall Street does. Given what’s at stake, Grewal told DL News, Coinbase is willing to take the case all the way to the US Supreme Court if necessary.
“We fully understand that these are important issues, and important issues tend to get appealed and litigated through appellate courts all the way to the Supreme Court,” Grewal said.
It doesn’t matter if it takes a long time. The clarity would be worth the trouble, Grewal said.
“We’re patient people,” he said.
Not his first rodeo
This is not Grewal’s first go-around in a high-stakes duel between a Silicon Valley firm and the government.
A former judge in San Jose, California, he traded the bench for the plush executive suite of a Silicon Valley powerhouse in 2016 when he joined Facebook, now Meta, as deputy general counsel.
Grewal helped shepherd the tech giant through the Cambridge Analytica scandal. It stemmed from Russia’s efforts to manipulate the 2016 presidential election by flooding social media platforms such as Facebook with disinformation about Hillary Clinton, the Democratic Party’s nominee for president in 2016.
‘As someone who’s practised law for a couple of decades, all my instincts are to act in the shadows and resolve matters quietly.’
Paul Grewal
After joining Coinbase in 2019, Grewal found himself in a very different type of fight. And unusually for a defendant facing the SEC, Coinbase has elected to take its fight public.
Brian Armstrong, Coinbase’s outspoken CEO, hasn’t been shy about using social media to rebut Gensler’s argument that cryptocurrencies are covered by existing securities laws.
Armstrong has also been at the forefront of the industry’s criticism of the Biden Administration for “regulation through enforcement” rather than legislation.
5/ Regulation by enforcement doesn’t work. It encourages companies to operate offshore, which is what happened with FTX.
— Brian Armstrong 🛡️ (@brian_armstrong) February 8, 2023
Grewal has punctuated his social media feeds with barbs against the regulator, or sarcastic offers to help the SEC with their online security following the regulator’s high-profile hack in January.
He has also echoed other crypto leaders by asserting the US is “falling behind” when it comes to regulating crypto. The US is “pushing the technology and the innovators overseas due to lack of clear rules and regulations for crypto,” Grewal said.
But he said being so public doesn’t come naturally.
“As someone who’s practised law for a couple of decades, all my instincts are to act in the shadows and resolve matters quietly,” he said.
Coinbase “has a responsibility to educate the wider public on what its government is doing in its name and why we believe they’re so deadly wrong.”
What the case is about
The crucial question in the Coinbase case is whether tokens like Cardano’s ADA, Solana’s SOL and Polygon’s MATIC — all listed in the SEC’s lawsuit — are, indeed, investment contracts and subject to securities laws.
The SEC argues that a purchaser of, say, ADA, is funding Cardano’s growth and expects to profit from it, which the agency says is clearly an investment contract.
Coinbase, on the other hand, says the purchase of an ADA token doesn’t give the investor a share in Cardano’s operations any more than the purchase of a Beanie Baby gives the buyer a vote in the running of its manufacturer.
The exchange’s lawyers argued this point in a January hearing held before Failla.
“Like all lawyers, we like to reason by analogy and show that if something is true, all sorts of absurdities can follow from that,” Grewal said.
“And our point about Beanie Babies — or Pokemon cards or Taylor Swift tickets — is that buyers might have hopes and dreams that these things will appreciate in value, but it doesn’t mean those Beanie Babies or tickets or cards are securities.”
The SEC filed its lawsuit against Coinbase in June within 24 hours of a similar one against Binance.
In both cases, the SEC alleges that the companies operated illegal exchanges, listed unregistered securities, and combined functions that in regulated exchanges are separated to mitigate conflicts of interest.
There was a crucial distinction, however.
In Binance’s case, the SEC added fraud charges against the exchange and its then-CEO, Changpeng Zhao.
During a Binance hearing on January 22, the SEC’s lawyer appeared to contradict his own colleague’s arguments made during the Coinbase hearing on January 17.
The SEC contended that the issuance of tokens and their ensuing sale establishes an investment contract.
But the SEC said the tokens themselves don’t represent the investment contract because they are simply lines of code.
Nuanced argument
It’s the type of nuanced argument litigants make all the time.
Indeed, the SEC itself made this same distinction in a case against payment network firm LBRY. The regulator argued that the firm conducted an unregistered securities offering when it sold its LBC tokens to raise money.
The judge sided with the SEC, but did not rule on whether or not LBC was a security.
Nevertheless, Grewal and his fellow crypto lawyers say the SEC is trying to have it both ways, and this lack of consistency should help undermine its case against Coinbase. At least, they hope judges see it that way.
Rulings in the Ripple support that distinction, too, Grewal said.
A chink in the armour
The crypto community seized on what appeared to be the SEC contradicting itself. After a year-plus of blanket enforcement actions, it was satisfying for them to see what could be a chink in the SEC’s armour.
So the tokens themselves are once again the securities? What was said to a SDNY judge last week, in open court, was false? https://t.co/9Q686MVgeF
— paulgrewal.eth (@iampaulgrewal) January 24, 2024
“We have a fancy legal term of art to describe that phenomenon — they were talking out both sides of their mouth,” Grewal said when asked about the incident.
“That’s just so absurd, for not only the same commission but the same lawyers representing the commission to tell two federal judges two very different things.”
Grewal said the muddled argument, combined with Failla’s evidently strong understanding of the arguments, was encouraging.
“We’re going to get a fair hearing in this case, and that’s all you can ever ask for,” he said.
Contact the authors at adam@dlnews.com and joanna@dlnews.com
