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Non-Fungible Tokens (NFT) Newsroom

Regulation by Enforcement in the Digital Assets Space

Regulation by Enforcement in the Digital Assets Space

With litigation heating up in the NFT space, industry stakeholders are seeking to define whether digital assets such as utility tokens and certain tokens relating to decentralized autonomous organizations (DAOs), are securities, and therefore subject to federal securities laws. With fraud running rampant in the NFT arena and crypto world, regulation and oversight is clearly necessary, however, the question remains - how should digital assets be regulated, and who decides?

The U.S. Securities and Exchange Commission (“SEC”) was recently accused of overreach in regulating the digital asset industry by enforcement.

Ishan Wahi (“Ishan”), former Coinbase employee, his brother, Nikhil Wahi (“Nikhil”), and friend Sameer Ramani (“Sameer”) (collectively, “the Wahi Defendants”) have moved to dismiss charges of alleged insider trading brought by the SEC in Securities and Exchange Commission v. Wahi et al., 2:22-cv-01009.**

The SEC charged the Wahi Defendants with insider trading last July, alleging that Ishan used information he gained while working at Coinbase to tip off Nikhil and Sameer about tokens that were about to be listed on Coinbase. Nikhil and Sameer then used this information to trade ahead of dozens of listing announcements, earning at least $1.1 million in illicit profits.

Coinbase is one of the largest crypto asset trading platforms in the U.S., with approximately 110 million verified users. According to the SEC’s Amended Complaint (“Am. Compl.”), in October 2020, Coinbase hired Ishan as a manager in its Assets and Investing Products Group where he was responsible for supporting and coordinating the Coinbase listing announcements. Am. Compl. ¶ 27. As part of this role, Ishan was privy to confidential, non-public information and was directly involved in the asset listing process by having first-hand knowledge of what crypto assets Coinbase planned to list and when Coinbase planned to announce an asset listing. Id. ¶ 30. Between at least June 2021 and April 2022, the Wahi Defendants engaged in a scheme – carried out over multiple months, involving multiple Coinbase listing announcements – to trade on inside information regarding nine crypto asset securities. Ishan repeatedly tipped Nikhil and Sameer with material, non-public information in advance of Coinbase’s listing announcements of the crypto asset securities and Nikhil and Sameer, repeatedly traded using that information, reaping substantial profits. Id. ¶ 37-39.

The SEC’s action is grounded on its assertion that the nine crypto tokens at issue are “securities” and are thus subject to federal securities laws because they are "investment contracts" — that is, they were offered and sold to investors, who made an investment of money in a common enterprise with a reasonable expectation that they would profit from the efforts of others. Id. ¶ 100. The SEC alleges that, in violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, Ishan misappropriated material non-public information about these tokens from his employer, and tipped Nikhil and Sameer, who subsequently profited off of trades in those tokens. Id. at 62-64 ¶¶ 1-8.

The Wahi Defendants filed a motion to dismiss the SEC's action (“Def.’s Mot.”), accusing the SEC of abusing its power by attempting to broadly regulate digital assets through the courts rather than obtaining such authority from Congress. The Wahi Defendants argued that the tokens at issue do not qualify as “investment contracts” since they all were purchased on the secondary market. “The developers who created the tokens at issue have no obligations whatsoever to purchasers who later bought those tokens on the secondary market. And with zero contractual relationship, there cannot be an “investment contract. It is that simple.” Def.’s Mot. at 1.

The Wahi Defendants further suggest that the SEC is acting outside the scope of its authority and running afoul of the Supreme Court's “major questions” doctrine. See Def.’s Mot., at 33-39. The “major questions” doctrine applies when “agencies assert[] highly consequential power beyond what Congress could reasonably be understood to have granted.” W. Va. v. EPA, 142 S. Ct. 2587, 2609 (2022).

Unsurprisingly, as this is a novel area of law, multiple crypto advocacy groups have filed amicus briefs in support of the Wahi Defendants motion to dismiss, as the legal issues have potential ramifications beyond the parties directly involved.

  • The Blockchain Association The Blockchain Association (the “Association”), an association that represents nearly 100 member companies in the blockchain industry, including software developers, infrastructure providers, exchanges, custodians, investors, and others supporting the public blockchain ecosystem, moved to file a brief as amicus curiae (“Association Brief”) to offer insights not presented by or available to the parties. As an industry group made up of more than one hundred members, the Association has significant insight into the blockchain and digital assets industry at large. The Association understands how participants throughout the industry utilize tokens, and thus how a decision here might affect the space, even outside of the tokens at issue in this case. In particular, the Association has a significant interest in this litigation, “because in this nascent area, overly broad court rulings could negatively affect the blockchain industry in entirely unanticipated and unintended ways.” Association Brief at 2.

    The Association Brief addresses how the SEC’s ongoing strategy of regulation by enforcement in the digital assets space, and its history of inconsistent, incomplete, and confusing public statements, have hurt the industry. As stated in the brief, “The SEC’s allegations appear to go beyond enforcing current regulations; the SEC instead is proclaiming new market rules, skirting its obligations to provide the public an adequate opportunity to weigh in on those rules, as would be proper under the Administrative Procedure Act (the “APA”).” – Association Brief at 13.

  • Investor Choice Advocates Network Investor Choice Advocates Network (“ICAN”), a non-profit, public interest organization focused on expanding access to markets by underrepresented investors and entrepreneurs, moved to file an amicus curiae brief (“ICAN Brief”) regarding whether the choice to regulate digital assets is a “major question” not delegated to the SEC through the term “investment contract”. The brief discusses whether the sufficiency of the current regulatory framework provides the SEC with the requisite authority to regulate digital assets. In the brief, ICAN asks the Court not to stretch the meaning of “investment contract” to allow the SEC to regulate an entire industry without unambiguous and explicit authority from Congress, which ICAN argues, is absent in this case. See ICAN Brief at 12.

  • The Chamber of Digital Commerce The Chamber of Digital Commerce (the “Chamber”), an organization that represents more than 200 entities that utilize or are involved with blockchain technology, including international financial institutions, global investment firms, leading software developers, and startups, moved to file an amicus curiae brief (“Chamber Brief”) regarding the scope of the SEC’s jurisdiction over digital assets and whether secondary market trades of digital assets should be considered “securities transactions” within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. As stated in the brief, “This litigation implicates that interest and presents a novel issue of great significance to the Chamber and its members. In bringing claims of securities fraud under Securities Exchange Act Section 10(b) and Rule 10b-5, the SEC necessarily asks this Court to hold that secondary market trades in nine digital assets constitute “securities transactions” under applicable law. That request is problematic for a host of reasons.” See Chamber Brief at 2-3.

Criticism of the SEC’s action reaches far beyond the Wahi Defendants and crypto advocacy groups. When the SEC filed its initial Complaint in July 2022, Commissioner Caroline D. Pham of the Commodity Futures Trading Commission issued a stark remark , stating it was a "striking example of 'regulation by enforcement'" and warned that the SEC's claims could have broad implications beyond this case. According to Ms. Pham, “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.”

The issue of whether tokens are securities has been a key focus of the SEC. Other SEC litigations involving allegations that tokens are securities include (but are not limited to) SEC v. Ripple, Inc., No. 20-cv-10832 (AT) (SN) (S.D.N.Y.) and SEC v. LBRY, Inc., No. 21-cv-00260-PB (D.N.H.) .

**In addition to the SEC’s civil action, the U.S. Department of Justice brought criminal charges against the Wahi Defendants for the same conduct in what Manhattan U.S. Attorney Damian Williams called “the first ever insider trading case involving cryptocurrency markets.” See U.S. v. Wahi, No. 22-cr-0392 (S.D.N.Y.).

What are your thoughts regarding regulation by enforcement? Let us know via LinkedIn or Twitter and stay tuned to Ingram’s NFT Newsroom to learn more about the latest developments and announcements.


By: Olivia Lee Jones


OliviaJones