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August 10, 2023 Feature

End of Games or Endgame? The SEC V. Wahi Settlement and What It Means for the Blockchain Industry

Jonathan E. Schmalfeld and Romaine C. Marshall

In a major twist, the U.S. Securities and Exchange Commission (the Commission) suffered a significant setback in its battle against what it labels as “unregistered crypto asset securities.” Will this mark a turning point in the Commission’s enforcement strategy, or is it a strategic withdrawal to consolidate resources for the forthcoming clash with Coinbase, the largest digital asset exchange in America?

To understand the implications of this development, we delve into the Commission’s legal proceedings against former Coinbase employee Ishan Wahi, the recent resolution of the case, and its potential impact on the blockchain industry.

Background on Dispute

In July 2022, the U.S. Department of Justice (DOJ) and the Commission each alleged insider trading violations against a former Coinbase employee, his brother, and an alleged acquaintance of his. DOJ brought charges of wire fraud against the three defendants in the Southern District of New York without any allegations of securities law violations, while the Commission brought a civil claim for insider trading in violation of Section 10(b) of the Securities Exchange Act of 1934 [15 U.S.C. § 78j(b)] and Rule 10b-5 thereunder in the Western District of Washington against the same three defendants.

The factual allegations in both the Commission and DOJ cases were largely the same: Former Coinbase product manager Ishan Wahi took insider information from his role at Coinbase about what digital assets the exchange was planning to list and gave that information to his brother Nikhil Wahi (collectively the “Wahi Brothers”) and former college roommate Sameer Ramani. Nikhil and Sameer then bought those assets ahead of their listings and realized at least $1.5 million in combined gains after those assets had predictable bumps in value after being announced for listing on one of the largest cryptocurrency exchanges in the world.

Both Ishan and Nikhil were taken into custody and pled guilty to DOJ’s wire fraud conspiracy charges, while Sameer is still at large. However, in what was a surprise to many, rather than also admitting to liability in the Commission’s action, the Wahi Brothers mounted a stout and seemingly well-funded defense against the Commission. This defense was supported by amicus filings of industry participants such as the Blockchain Association, Paradigm, and even Ishan’s former employer Coinbase.

Secondary Sales of Digital Assets

In various actions, both against digital asset issuers and third parties such as the Wahi Brothers, the Commission has alleged that over seventy digital assets are unregistered crypto asset securities. It is largely agreed upon that the primary sales of digital assets are “investment contracts” when they are explicitly or implicitly understood by buyers to be fund-raising efforts to further build the capabilities of the blockchains that drive those digital assets.

However, it is disputed as to what exactly constitutes an explicit or implicit promise, which makes buyers rely on “the entrepreneurial efforts of others” for the digital assets’ value. It is also disputed as to what effect, if any, a buyer’s subjective intent to actually use the token (i.e., a “utility” token) has on the securities analysis. But it is largely agreed that if a digital asset is sold in “a transaction that is in reality an investment (that is, a transaction of the type in which stock is often given),” then that transaction is a securities transaction.

Also, it is still unsettled whether a digital asset can be initially sold in a securities transaction, but later be sold on the secondary market as something else. Commission Chairman Gary Gensler has taken the position that “everything else other than bitcoin is a security,” indicating a “once a security, always a security” position. Others have taken the position that once a blockchain has reached “sufficient decentralization” as to no longer depend on a centralized actor or group of actors to run that blockchain, then the sales of that blockchain’s native digital assets are no longer securities transactions.

There have been 210 federal appellate and Supreme Court decisions since the seminal Supreme Court case SEC v. W.J. Howey in which the Court determined whether the underlying allegations were sufficient to determine if the contract, transaction, or scheme at issue was an investment contract. The authors of a study of those 210 cases found that whether any particular transaction is an “investment contract” is fact specific and requires a transaction-by-transaction analysis.

However, there has been no federal appellate level case that has found the underlying asset being sold is a security. That is to say, as in Howey, while certain transactions involving orange groves can constitute investment contracts, no federal appellate court has ever found the orange grove itself or the oranges from the grove to themselves be securities.

Motion to Dismiss and Amicus Arguments in Wahi

In the Commission’s action against the Wahi Brothers, the Commission affirmatively alleged that at least nine of the 25 tokens traded by the defendants ahead of their Coinbase listings are “crypto asset securities,” the trading of which on nonpublic information constitutes a violation of Section 10(b) of the Exchange Act [15 U.S.C. § 78j(b)] and Rule 10b-5 thereunder. While neither the Commission nor DOJ released the full list of assets traded by Ishan, Nikhil, and Sameer, we do know by comparing DOJ’s Indictment to the Commission’s Complaint that TRIBE, ALCX, GALA, and ENS are all coins traded by the indicted individuals but not alleged to be securities in the Commission Complaint. To date, no attorney has been able to find a common distinguishing feature differentiating the nine tokens named by the Commission in its Complaint as crypto asset securities and the sixteen other tokens traded by the Wahi Brothers, which were not named as crypto asset securities.

Because there was no claim that the Wahi Brothers issued the digital assets that the Commission alleged to be securities, the Commission’s litigation against them was going to be the first major case to determine when and how secondary sales of digital assets could be securities transactions.

In the Wahi Brothers’ Motion to Dismiss, they criticized the SEC’s refusal to engage in rulemaking for the digital asset industry and classified the SEC’s one-off enforcement actions against them as “a process designed to produce more heat than light.” They went on to argue that the “essential ingredients” in an “investment contract” is a contract for sale of assets plus something else (a land sale plus the promises to manage orange groves on it, as was the case in Howey). These “essential ingredients” listed by the Wahi Brothers are (1) a contract; (2) a post-sale obligation on the initial seller; and (3) a right to share in the venture’s profits.

Immediately after the Commission’s case against the Wahi Brothers was filed, Ishan’s former employer, Coinbase, released a statement supporting the criminal prosecution of the Wahi Brothers but denouncing “the SEC’s decision to file these securities fraud charges and the substance of the charges themselves.” The article stated “TLDR: Coinbase does not list securities on its platform. Period.” Coinbase went on to file an amicus brief in support of the Wahi Brothers’ Motion to Dismiss, reiterating the exchange’s position that it does not list crypto asset securities on its platform and requesting the court “dismiss this lawsuit as foreclosed by the long-settled understanding of the securities laws, and as a travesty of fair notice and fair process in which the practices of a respected company are left to be defended by the criminals who harmed it.”

Coinbase’s legal head announced the filing on Twitter, stating, “Instead of focusing on practical, lasting solutions like developing rules or registration options, the Commission has prioritized actions like this one that distort the legal definition of an investment contract beyond recognition.”

SEC v. Wahi Resolution

Faced with this stout legal defense, rather than litigating the issue as to what secondary transactions of digital assets are securities transactions, on April 3, 2023, the parties jointly requested to delay further briefing after having reached a settlement in principle, which was awaiting finalization. That settlement was seemingly finalized on May 30, 2023, with the parties requesting a consent motion for final judgement.

The settlement does not admit any conclusions about the tokens themselves constituting securities and does not require the Wahi Brothers to pay any fines on top of what they are already paying under DOJ criminal pleas. The only ongoing obligations on the Wahi Brothers is a permanent injunction against them from violating Section 10(b) of the Securities Exchange Act.

While the Commission has claimed this settlement as a win, the Wahi Brothers are in exactly the same position as they were prior to the Commission bringing this lawsuit and face zero additional fines or obligations that they would not otherwise be under. By any objective view, this resolution was a major victory for the Wahi Brothers, the buyers and sellers of the digital assets at issue, and the exchanges where those digital assets are bought and sold.

What the Wahi Resolution Means for the Blockchain Industry Going Forward

For the blockchain industry, an optimistic view of the Wahi settlement is that the Commission saw the weakness in its position that the secondary sales by the Wahi Brothers were securities transactions and waived the white flag when faced with the spirited and well-funded defense of the Wahi Brothers and amicus filers.

A pessimistic view is that the Commission chose not to devote further resources going after two individuals when it is seemingly preparing to sue Coinbase having already served the exchange with a Wells notice. Either way, because the settlement occurred prior to the Commission responding to the Wahi Brothers’ Motion to Dismiss, the industry is left guessing as to what arguments the Commission intends to make about the secondary sales of digital assets.

As of the writing of this article, there is an ongoing dispute between Coinbase and the Commission after Coinbase filed what the exchange has described as “a narrow action in federal court to compel the SEC to do one simple thing: respond yes or no to Coinbase’s pending rulemaking petition that asks the SEC to provide overdue guidance for the crypto industry.”

There is also pending legislation in the U.S. House of Representatives introduced by Representatives Tom Emmer (R-MN) and Darren Soto (D-FL) titled The Securities Clarity Act, which seeks to clarify the regulatory classification of digital assets, and comprehensive digital asset legislation in discussion draft form titled Digital Asset Market Structure, introduced by the joint House committees of Financial Services and Committee on Agriculture.

Commission Chairman Gary Gensler has recently stated under oath that the rules for digital assets are clear and no further congressional authority is needed for the SEC to regulate the industry. This contradicts his prior position that the Commission needed more Congressional authority to regulate the digital asset industry.

In the end, the settlement in Wahi leaves the industry with more questions than answers as to the regulatory status of the secondary sales of digital assets. Industry participants are still looking for clarity from Congress, administrative agencies, and the courts for answers to these unresolved questions.

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    Jonathan E. Schmalfeld


    Jonathan E. Schmalfeld is an associate with Polsinelli in St. Louis, Missouri. His practice focuses on advising clients in domestic and international digital asset and privacy matters.

    Romaine C. Marshall


    Romaine C. Marshall is a shareholder in Polsinelli in Salt Lake City, Utah. He helps organizations navigate legal obligations relating to data innovation, privacy, and security.