SEC Files Lawsuit Against Coinbase Over Allegations of Operating an Unregistered Securities Exchange

The U.S. Securities and Exchange Commission (SEC) has taken legal action against Coinbase (COIN), a U.S. cryptocurrency exchange, accusing them of violating federal securities law. This lawsuit comes just one day after the SEC filed a similar complaint against Binance.

The SEC alleges that Coinbase has been functioning as an unregistered broker, exchange, and clearing agency concurrently. The commission argues that Coinbase engaged in customer solicitation, order handling, bid facilitation, and acted as an intermediary without proper registration. While the lawsuit specifically mentions Coinbase, Inc. and Coinbase Global, Inc. as defendants, it does not name Brian Armstrong, the founder and CEO, or any other executives involved.

"The Coinbase Platform merges three functions that are typically separated in traditional securities markets – those of brokers, exchanges, and clearing agencies," the SEC suit said. "Yet, Coinbase has never registered with the SEC as a broker, national securities exchange, or clearing agency, thus evading the disclosure regime that Congress has established for our securities markets."

In a press release issued on Tuesday, SEC Chair Gary Gensler expressed that these various functions were "intermingled" or "mixed together."

"Coinbase’s alleged failures deprive investors of critical protections, including rulebooks that prevent fraud and manipulation, proper disclosure, safeguards against conflicts of interest, and routine inspection by the SEC," he said.

In a statement, Paul Grewal, the Chief Legal Officer of Coinbase, emphasized the need for the development of cryptocurrency-specific legislation. Grewal made this statement while also testifying before the House Agriculture Committee on Tuesday.

“The SEC's reliance on an enforcement-only approach in the absence of clear rules for the digital asset industry is hurting America’s economic competitiveness and companies like Coinbase that have a demonstrated commitment to compliance. The solution is legislation that allows fair rules for the road to be developed transparently and applied equally, not litigation. In the meantime, we’ll continue to operate our business as usual," he said.

The SEC highlighted Coinbase's Prime, Wallet, and staking products, along with the tokens listed on its platform, as areas where the company allegedly breached federal securities laws.

The news of the lawsuit caused a significant drop in both the crypto market and Coinbase's premarket stock price.

The SEC argued that Coinbase was aware that certain cryptocurrencies it offered to U.S. customers might meet the criteria for being classified as securities. This claim was supported by the SEC's reference to Coinbase's Crypto Ratings Council initiative, which the exchange launched in 2019 to establish an unofficial framework for determining whether a cryptocurrency qualified as a security.

"During this period, Coinbase made available on the Coinbase Platform crypto assets with high 'risk' scores under the CRC framework it had adopted," the SEC said. "In other words, to realize exponential growth of the Coinbase Platform and boost its own trading profits, Coinbase made the strategic business decision to add crypto assets to the Coinbase Platform even where it recognized the crypto assets had the characteristics of securities."

The lawsuit further claimed that Coinbase detected "troubling statements" made by issuers, indicating any statements suggesting that the issued token could be classified as a security.

In the lawsuit, the SEC classified tokens associated with foundations, companies, or protocols such as Solana (SOL), Cardano (ADA), Polygon (MATIC), Sandbox (SAND), Filecoin (FIL), Axie Infinity (AXS), Chiliz (CHZ), Flow (FLOW), Internet Computer (ICP), Near (NEAR), Voyager (VGX), Dash (DASH), and Nexo (NEXO) as securities.

The SEC highlighted that each of these tokens is listed on Coinbase's Prime or Wallet services. Furthermore, the lawsuit delved into the intricate histories of these tokens and elucidated the SEC's perspective on their categorization as securities.

The SEC additionally referred to Coinbase's public registration statement, highlighting that the company acknowledged the potential classification of certain assets it listed as securities in the risk factors section.

Earlier this year, the SEC issued a warning to Coinbase, indicating the possibility of a lawsuit against the exchange. They sent a Wells Notice, to which Coinbase provided a response in April.

In the lawsuit filed on Tuesday, the SEC accused Coinbase of breaching the Exchange Act on four different counts by failing to register. The SEC also claimed that Coinbase violated the Securities Act. The regulatory body is seeking a permanent injunction to prevent further violations, as well as disgorgement and civil penalties.

In contrast to the Binance lawsuit, the SEC did not make any allegations against Coinbase regarding the commingling of customer funds or the transfer of such funds by company executives to other entities.