Last week, Coinbase Global Inc. (“Coinbase”) avoided confrontation with the Securities and Exchange Commission (“SEC”) by announcing that it was putting aside a high-profile digital asset lending product, Lend. The announcement came two weeks after Coinbase revealed it had received a well SEC notice warning the company of its intention to sue the planned launch of Coinbase’s October loan.
The product would offer users a high yield alternative to traditional savings accounts, allowing them to lend their USDC stablecoin to Coinbase at 4% interest. After receiving the well Notice, the crypto firm has taken to the internet to criticize the SEC, which apparently issued the warning after Coinbase’s months-long effort to productively engage with the Commission, according to the company. This episode shows that as digital asset innovation progresses, regulators now appear poised to enter the market with enforcement actions targeting these new instruments.
The issuance of a well notice as a result of discussions between the SEC and its investigative careers is common. What is not so common is a well notice that threatens to take enforcement action for conduct that has not yet taken place. This is because, traditionally, the well the notice serves to inform the subject of a preliminary ruling in order to recommend that the SEC initiate past malpractice proceedings. Here, the SEC’s decision to go ahead with the app seemed to hinge on Coinbase’s future launch of Lend.
Coinbase claimed that the SEC refused to provide legal justification for issuing the well opinion, except that the regulator had apparently determined that the loan “involves[s] a title â, requiring registration in light of two landmark Supreme Court rulings: Securities & Exchange Commission v. WJ Howey, 328 US 293 (1946) and Reves c. Ernst & Young, 494 US 56 (1990).
In Securities & Exchange Commission v. WJ Howey, the Supreme Court established the famous Howey Test that is frequently used in the digital asset space to determine if these new products are securities subject to SEC registration and oversight. Under the Howey Test, an investment instrument is a security where there is: (1) the investment of money, (2) in a joint venture, (3) with the expectation of a profit, (4) derivative of efforts of others.
Interestingly, according to Coinbase, the SEC also cited Dreams vs. Ernst & Young, a Supreme Court ruling determining when a loan instrument constitutes collateral. Although the term ânoteâ is included in the legal definition of a security, under federal securities law, notes with a maturity of nine months or less are not securities. See Securities Act 1933 Â§ 3 (a) (3); Securities Exchange Act of 1934 Â§ 3 (a) (10). In addition, the courts have provided additional exceptions through case law, and Dreams determined that the Notes are not securities if they present a âfamily resemblanceâ with excluded categories, including: (1) Notes delivered under consumer finance; (2) notes secured by a residential mortgage; (3) short-term notes secured by a lien on a small business or certain of its assets; (4) notes attesting to a loan of character to a bank client; (5) short-term notes secured by an assignment of receivables; (6) notes that formalize an open account debt contracted in the normal course of business; and (7) notes attesting to commercial bank loans for current operations. That the SEC apparently cited both Howey and Dreams in support of its position may indicate that the regulator has determined that certain aspects of the loan constitute both a security and an investment contract and a note.
While Coinbase’s decision to forgo its planned launch of Lend seemingly avoids a head-on collision with the SEC, the events of the past month demonstrate both the SEC’s willingness to pursue enforcement action in the digital asset space as well. as the crypto industry’s dissatisfaction with the advice provided by the SEC regarding the ground rules for conducting digital business. Without these tips, episodes like this can become commonplace.
Copyright Â© 2021, Sheppard Mullin Richter & Hampton LLP.Revue nationale de droit, volume XI, number 272