This is the second part of my column about the crackdown on insider trading involving crypto. In the first part, I discussed the criminal indictment of Nathaniel Chastain, a former product manager at the OpenSea NFT marketplace. I also discussed the SEC’s allegations against former Coinbase employee Ishan Wahi, his brother and his friend, based on the “misappropriation” theory of insider trading.

Powers On… is a monthly opinion column from Marc Powers, who spent much of his 40-year legal career working with complex securities-related cases in the United States after a stint with the SEC. He is now an adjunct professor at Florida International University College of Law, where he teaches “Blockchain & the Law.”

Since the United States v. O’Hagan Supreme Court case in 1997, the misappropriation theory of insider trading liability has been explicitly recognized. Both before that date and after, “misappropriation” of company secrets or confidential information used in connection with stock trading has been an active area of Securities and Exchange Commission enforcement and criminal prosecutions.

Examples include a former writer for The Wall Street Journal in United States v. Winans; employees at the magazine stand Hudson News in Securities Exchange Commission v. Smath; a printer at a company that printed tender offer documents in Chiarella v. United States; and more recently, financial analysts in United States v. Newman and Salman v. United States. On the same date as the SEC filing against Ishan Wahi and his two associates, the U.S. attorney for the Southern District of New York unsealed a parallel criminal indictment that charged these same three defendants with wire fraud and wire fraud conspiracy.

Tippees that receive material, nonpublic or confidential information from a tipper violate insider trading rules if they know the tipper breached a duty they owed to another and received some sort of personal benefit from the tip. The Supreme Court said in the 2016 Salman case that the personal benefit need not be financial or pecuniary. The benefit requirement is satisfied by bestowing a gift of this information on a trading relative or a close friend. 

Frankly, it’s about time that the SEC and U.S. attorney’s offices focused on real crimes and fraud. This is precisely what insider trading is: fraud. It’s an unfair trading advantage by someone who learns confidential information and trades on it for economic gain and profits. But this Wahi case begs the question of what exactly insider trading is. As I stated before, insider trading involves trading in “securities.” Accordingly, to bring its case, the SEC is alleging that at least nine of the tokens listed on Coinbase and traded in advance by the defendants fit within the “investment contract” analysis of the Howey test. But do they really?

The SEC says that some of the tokens are “purported” to be governance tokens but are “securities.” So, it is worth noting this warning shot. For those token issuers taking comfort from lawyers who have decreed their tokens non-securities because they are governance tokens, beware — and perhaps get another opinion from a qualified securities lawyer. 

Apart from the interesting aspects of this particular case, what does it mean for others, such as Coinbase itself? Well, the SEC is claiming that certain tokens on its exchange are “securities.” If that is so, then Coinbase should be registered as a “securities exchange” pursuant to the Securities Exchange Act of 1934. Not surprisingly, a few days after the SEC filing, it was reported that Coinbase was under SEC investigation.

My view is that SEC Chairman Gary Gensler is using this case as a further “land grab” to take jurisdiction over digital assets — and crypto specifically — away from the Commodity Futures Trading Commission. I have said this before. Indeed, CFTC Commissioner Caroline D. Pham also sees through the SEC’s efforts.

On the day of the complaint filing, she issued a public statement, saying: “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. […] Regulatory clarity comes from being out in the open, not in the dark.”

Pham also said, “SEC v. Wahi is a striking example of ‘regulation by enforcement.’” Four days later, on July 25, CFTC Chair Rostin Behnam spoke at the Brookings Institute and echoed the view that the CFTC would be the natural and best regulator to have oversight over crypto.

What about those nine “issuers” of the nine tokens the SEC claims are securities? Well, they, too, can expect to be subject to independent investigations by SEC staff looking into registration violations. Each of their ICOs or offerings is within the five-year statute of limitations for the SEC to bring enforcement actions against them. Stay tuned.

The opinions expressed are the author’s alone and do not necessarily reflect the views of Valideapp nor Florida International University College of Law or its affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice.