A potential legal battle between
Global and the Securities and Exchange Commission could take years to play out. But investors might get a strong sense of the crypto exchange’s fate much sooner when a judge issues a decision in another closely watched case.
That case, between the SEC and Ripple Labs, is potentially speeding to a conclusion. As soon as this spring, a judge could decide whether “XRP,” a token created by Ripple, is a security. Such a move could subject XRP and the exchanges that allow it to trade to SEC oversight.
But the decision has even wider ramifications. Scores of crypto tokens look similar to XRP, meaning that they too would likely fall in the agency’s remit. Exchanges that allow investors to buy and sell securities themselves must register with the SEC, which would make it near-impossible for Coinbase and other platforms to completely avoid the SEC’s grasp.
Coinbase (ticker: COIN) investors were already watching the Ripple case closely, but its outcome became even more critical on Wednesday, after Coinbase disclosed a possible SEC action.
The trading platform said it received an official warning that SEC staff is primed to recommend an enforcement action against it. The so-called “Wells notice” gives Coinbase’s attorneys one last chance to provide information that would dissuade the agency. If staff recommends an action, the SEC’s commissioners would vote on whether or not to bring a lawsuit.
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Coinbase stock as of late Thursday morning had fallen about 11%, to $68.38.
Coinbase says it believes the potential lawsuit concerns the assets it lists as well as its “staking” service, which helps investors post their tokens to different blockchains in exchange for yield, with Coinbase taking a cut. Analysts have seen staking as a potential major source of revenue, but an attack that accused the platform of allowing securities to trade would be especially damaging since it strikes at the heart of its trading revenue.
Coinbase says it has a rigorous process to ensure it doesn’t list securities on its exchange and that the SEC hasn’t told them what tokens it thinks qualify for the designation.
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Unlike the Coinbase case, which hasn’t even been filed, the Ripple case is more than two years old. In December 2020, the SEC sued the company and two executives in federal court in the Southern District of New York, accusing them of conducting a $1.3 billion unregistered securities offering. Coinbase suspended XRP trading the following month.
The determination of whether XRP is a security rests on the “Howey test,” named after a U.S. Supreme Court case in which the court created a definition for when a transaction qualifies as an investment contract. In that decision, the court wrote such a determination hinges on “whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.” Ripple denies that XRP meets that standard.
Ripple and the SEC finished briefing the court on summary judgment in that case late last year, and Coinbase and other crypto organizations filed amicus briefs in Ripple’s support. In an interview early this month, Ripple Chief Legal Officer Stuart Alderoty said he expected a decision could come some time between the end of March and September, based on how long it has taken the court to issue similar decisions in the past.
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If Ripple loses, token issuers to avoid a similar fate would have to attempt to register their own coins with the SEC, a costly and uncertain process. Coinbase and other platforms that allowed unregistered securities to trade could face their own lawsuits. SEC Chair Gary Gensler has also said crypto platforms also ought to disentangle many of the services some of them currently provide—such as trading, custody and exchange services—into separate entities.
The judge’s decision won’t be binding on other courts, but would likely be used by the SEC or potential defendants in future cases. If Ripple loses, “of course we’d appeal,” Alderoty said, noting that the decision would have wide implications not just for Ripple but for the wider industry.
Coinbase says it will fight any SEC lawsuit if it comes, and if Ripple is any guide, such a battle could take years. But make no mistake, for practical purposes, the verdict is coming much sooner.
Write to Joe Light at joe.light@barrons.com