What Was Coinbase Thinking When It Dissed the SEC?

(Bloomberg Opinion) -- The developing battle between Coinbase, one of the biggest U.S. cryptocurrency trading platforms, and the Securities and Exchange Commission has me wondering what exactly the crypto people are hoping to achieve. If anything, their brazen approach seems likely to get them more of the regulation they’ve been seeking to avoid.

For a financial institution with a market value of more than $50 billion, Coinbase is so far remarkably free of regulation. The cryptocurrencies that trade on the exchange haven’t been classified as securities, which the SEC oversees, or as derivatives, which the Commodity Futures Trading Commission oversees. As a result, it doesn’t face the requirements for safety, soundness and investor protection that the regulators impose on exchanges under their purview.

Now, though, Coinbase wants to offer a product called “Lend,” which would pay interest on cryptocurrency that customers park at the exchange. It doesn’t take a legal genius to recognize that such an offering would attract regulators’ attention, particularly when regulators have warned that they intend to subject crypto to greater scrutiny. There’s a strong case to be made that it’s essentially a bank account, and should be regulated as one. It also fits the Supreme Court’s well-known definition of an investment contract — a form of security that, as the SEC recently put it, entails “the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

So it should have come as no surprise when, on Sept. 1, Coinbase received a formal SEC notification, known as a Wells Notice, which the company said threatened civil injunctive action if it went ahead with the Lend product. Yet when CEO Brian Armstrong first disclosed the SEC’s notice in a series of late-night tweets on Sept. 7, he took the agency to task for not playing fairly, expressing dismay at its “sketchy behavior” and complaining that it had provided “zero explanation.” This was followed by an indignant blog post from Coinbase’s chief legal officer, an official company filing disclosing the Wells Notice, and much fervent discussion among finance geeks on Twitter. 

It’s pretty clear that Coinbase coordinated its response. The question is why, and what sort of legal advice they were relying on. Was Armstrong seeking to channel Elon Musk, who famously told 60 Minutes back in 2018 that he did not respect the SEC after the agency fined the Tesla CEO $20 million for a series of tweets? But even Musk waited a few months to attack, and Tesla had eight years of experience dealing with securities regulators and being a publicly traded company. Baiting the SEC after already receiving a Wells notice seems like a pretty big roll of the dice for a company that went public only in mid-April and hasn’t even filed its first 10-K.

Then there’s the timing. It follows from the Coinbase filing that executives waited almost a week, from Sept. 1 to late on Sept. 7, to let the public know about the Wells notice. This was soon enough to comply with SEC rules on the disclosure of “significant events,” but also allowed executives and directors, including the chief legal officer, to sell shares before the news broke. Over the next few days, Coinbase’s stock price declined about 7%. 

I doubt the sales represent illegal insider trading, as some on Twitter have suggested: The company described most of them as part of pre-arranged 10b5-1 stock-trading plans, and the chief legal officer had options that happened to vest on Aug. 31. But the optics aren’t great. Executives have been known to abuse 10b5-1 plans, and the company hasn’t provided in its public filings any specifics about the plans, including when they were adopted. (SEC rules don’t currently require that level of detail, although some companies do provide it.)

Thus, Coinbase has set itself up to be Exhibit A on the need for tougher regulation in two areas. One is expanding SEC oversight of crypto by defining more products as securities. The other is tightening rules on 10b5-1 plans — something SEC Chairman Gary Gensler has already said he plans to do. As long as there’s any ambiguity in the plans, people can point to well-timed sales as being a bit too well-timed. 

Satisfying as it might have been to call the SEC “sketchy,” it’s a decision that Armstrong may yet regret.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

©2021 Bloomberg L.P.