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The Securities and Exchange Commission filed insider trading charges against a former Coinbase product manager and two others for perpetrating a scheme to trade ahead of multiple announcements regarding certain crypto assets that would be made available for trading on the Coinbase platform. The crypto assets at issue were tokens issued using the ERC-20 protocol of the Ethereum blockchain.
The litigation asserts that the tokens were “securities” and subject to the provisions of federal securities laws, marking one of the first times the Commission has alleged specific tokens meet the definition of a security under the Howey test. “We are not concerned with labels, but rather the economic realities of an offering,” said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. “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.”
The treatment of crypto assets has long troubled compliance-minded investment advisers, who may struggle with how to address the legal and operational challenges associated with crypto assets. The action by the Commission indicates that it intends to continue pursuing violations of securities laws as it pertains to crypto assets. However, the Commission has so far, been reluctant to provide detailed guidance to firms to assist in the Howey analysis. In 2019, the Commission released a Framework for “Investment Contract” Analysis of Digital Assets, which provided various tests and conditions for determining whether a digital asset is a “security”, however, no definitive guidance has been released for assets which continue to fall into a gray area, currently assessed on a case by case basis.
Is it time to reassess your approach?
Asset managers have two routes to manage crypto assets:
- treat all digital assets as securities; or
- make a determination on a case-by-case basis.
There are pros and cons to each of these approaches, but the most conservative route is to assume all digital assets are securities. Many firms experience operational challenges when treating all crypto assets as “securities”, however, as the Coinbase litigation indicates, there may be much at stake if a firm gets it wrong.
As a minimum, firms who invest in crypto assets as a strategy for client accounts should be:
- Considering the applicability of their Compliance program to crypto assets.
- Ensuring service providers are well equipped to deal with unique crypto challenges, particularly in the areas of custody, trading and valuation.
- Reviewing how to treat employees who trade in crypto assets under their Code of Ethics and the application of material non-public information (MNPI) treatment protocols.