SEC insider trading case against Coinbase holds larger implications

The Securities and Exchange Commission filed insider trading charges against a former employee of cryptocurrency exchange Coinbase, which could hold larger implications over what the agency can and cannot regulate.

The SEC charged former product manager Ishan Wahi, as well as his brother and a friend, with illegally profiting off nonpublic information. As a product manager, Wahi had access to information about what tokens were soon to be listed on the exchange. The SEC alleges that, despite being specifically warned by his company not to do this, Wahi tipped off his brother and a friend of his as to the timing of these listings, and all three of them would buy the tokens ahead of time to take advantage of the fact that their prices tended to rise once on the exchange. According to the charges, the three of them made about $1.1 million of illicit profit this way, operating between June 2021 and April 2022.

“In nearly a year, the defendants collectively earned over $1.1 million in illegal profits by engaging in an alleged insider trading scheme that repeatedly used material, nonpublic information to trade ahead of Coinbase listing announcements,” said Carolyn Welshhans, acting chief of the enforcement division’s Crypto Assets and Cyber Unit. “As today’s case demonstrates, whether in equities, options, crypto assets, or other securities, we will vindicate our mission by identifying and combatting insider trading in securities wherever we see it.”

It is this mention of "securities," however, that raised certain hackles. Caroline Pham, a Republican member of the Commodity Futures Trading Commission, critiqued her sister agency in a statement by saying the order essentially is trying to regulate via enforcement because, through this action, the SEC has declared certain tokens to be financial securities in a world where there remains robust debate as to whether this is the case.

"The case SEC v. Wahi is a striking example of 'regulation by enforcement.'  The SEC complaint alleges that dozens of digital assets, including those that could be described as utility tokens and/or certain tokens relating to decentralized autonomous organizations, are securities. The SEC’s allegations could have broad implications beyond this single case, underscoring how critical and urgent it is that regulators work together.  Major questions are best addressed through a transparent process that engages the public to develop appropriate policy with expert input — through notice-and-comment rulemaking pursuant to the Administrative Procedure Act. Regulatory clarity comes from being out in the open, not in the dark," she said.

Coinbase agreed with her, saying in a statement of its own that the SEC is overreaching because it does not consider the tokens named by the agency in its insider trading cases to be financial securities. In fact, said the statement, Coinbase does not list securities at all.

"Seven of the nine assets included in the SEC’s charges are listed on Coinbase’s platform. None of these assets are securities. Coinbase has a rigorous process to analyze and review each digital asset before making it available on our exchange — a process that the SEC itself has reviewed. This process includes an analysis of whether the asset could be considered to be a security, and also considers regulatory compliance and information security aspects of the asset. To be explicit, the majority of assets that we review are not ultimately listed on Coinbase," said the statement.

The distinction, though, does not seem very important to the SEC; director of enforcement Gurbir Grewal said what an asset is called is less important than what is being done with it, such as insider trading.

"We are not concerned with labels, but rather the economic realities of an offering," said Grewal in a statement. "In this case, those realities affirm that a number of the crypto assets at issue were securities, and, as alleged, the defendants engaged in typical insider trading ahead of their listing on Coinbase. Rest assured, we’ll continue to ensure a level playing field for investors, regardless of the label placed on the securities involved."