On March22, 2023, the Securities and Exchange Commission (SEC) issued a Wells Notice to Coinbase Global, Inc. (Coinbase). The Wells Notice provides that the SEC staff had made a preliminary determination to recommend an enforcement action against Coinbase, the largest U.S. crypto exchange, for violations of federal securities laws, which may relate to the Coinbase spot market, staking service, Coinbase Prime, and Coinbase Wallet. Due to the Wells Notice, and corresponding Form 8-K regulatory filing made by Coinbase, the public stock price for Coinbase fell over 20% during the following two trading days. The Wells Notice is part of an increasing amount of scrutiny and overall regulatory attention being paid to crypto companies and trading platforms. The Wells Notice provided, in part, that Coinbase was offering and selling unregistered securities, in violation of federal law. It is not uncommon for the SEC to allege the sale of unregistered securities in order to bring enforcement actions across many industries, including the crypto industry specifically, and such allegations were just recently raised against the crypto exchange Kraken.
In its response to the SEC’s Wells Notice, Coinbase has alleged that detailed discussions regarding its business model took place with the SEC during its “going public” process in 2021, and that the issuance of this Wells Notice is in an effort to pressure Coinbase to accept the SEC’s view on digital assets on the Coinbase platform being treated as securities. It is important to note that during a “going public” process pursuant to the filing of an S-1 Registration Statement, an issuer is required as part of its effectiveness request letter, to include language stating that declaring the S-1 Registration Statement effective does not foreclose the SEC from taking any action with respect to the filing, nor may the company assert staff comments or the declaration of effectiveness a defense in any proceeding initiated by the SEC. While the foregoing language is part of the S-1 process specifically, the fundamental message is that even if, after discussions with the SEC on a given issue, there no longer seem to be issues with the business plans or operations of a given company, it does not preclude the SEC from brining enforcement actions at a later time in its discretion.
In response to the Wells Notice, Coinbase has publicly released a response to the SEC, and also filed a lawsuit against the SEC. While lawsuits against the SEC are inherently difficult to win, the lawsuit was filed in an effort to force the SEC to respond to a rule-making petition Coinbase filed last year to address multiple issues in the crypto industry and to propose and adopt rules to govern securities that are offered and traded digitally, to which the SEC has never responded. Coinbase is arguing that the SEC is violating the Administrative Procedure Act by failing to respond to the Coinbase petition in a reasonable amount of time. Part of the frustration of Coinbase is that they filed a petition asking for guidance and overall structure in which to operate without violating rules or regulations, to which there was no response, and instead a Wells Notice was issued.
It is currently unclear what the outcome of the battle between Coinbase and the SEC will be, and it may take years to fully resolve the issues being raised by both Coinbase and the SEC. However, the overall goal should be to clarify regulatory issues in the crypto industry, clearly define what digital assets should, and will be, classified as securities, and provide a clear framework in which crypto companies and platforms may operate without a constant concern of potential SEC enforcement actions.