A former Coinbase (NASDAQ: COIN) product manager will go down in history as the first digital asset exchange staffer to be convicted of insider trading.
On Tuesday, ex-Coinbase staffer Ishan Wahi pleaded guilty to two counts of conspiracy to commit wire fraud. Wahi, his brother Nikhil and a friend named Sameer Ramani were charged with insider trading in July 2022 by the U.S. Attorney’s Office for the Southern District of New York. The charges marked what the Department of Justice triumphantly called the “first-ever cryptocurrency insider trading case.”
Ishan Wahi, who originally entered a not guilty plea last August, faces a maximum penalty of 40 years when he’s sentenced on May 10. However, his brother Nikhil pleaded guilty to similar charges last year and received a 10-month sentence in January. Ramani reportedly fled the United States as the charges were being prepared and remains at large.
The felonious trio reaped around $1.5 million in illegal profits from their scheme, in which Ishan—a member of a private Coinbase messaging channel for staff involved in the listing process—tipped off his co-conspirators regarding which tokens Coinbase was preparing to list. Over 14 separate incidents, some 25 different tokens were purchased in advance of their listing and then sold shortly after their listing.
One day after multiple tokens made their Coinbase debuts in April 2022, blockchain sleuths observed that a single Ethereum wallet had purchased hundreds of thousands of dollars worth of the newly listed tokens prior to their listing.
While Coinbase CEO Brian Armstrong was quick to take a victory lap about having “immediately” launched an investigation into the crime, a study later found insider trading in as much as 25% of new token listings. This is despite Coinbase having publicly stated that its employees were “subject to trading restrictions and confidentiality obligations to ensure the integrity of our platform.”
Coinbase shares, which had more than doubled in value since the start of 2023, gave back some of those gains Tuesday. After closing Monday at $74.59, the shares closed Tuesday down 4.25% to $71.42. That’s still better than the shares closed out in 2022 but significantly below the nearly $370 peak following Coinbase’s April 2021 Nasdaq listing.
Meanwhile, the Coinbase insider fire sale continues unabated. Since February began, Armstrong has dumped nearly $5.7 million in Coinbase shares, adding to the $5.1 million he sold in January. Meanwhile, chief legal officer Paul Grewal sold $140,000 on February 6.
It’s almost as if they expect some bad news coming—like the Q4/FY22 numbers the company will report in two weeks’ time—and suspect the recent share price rally is about to get popped like a Chinese weather balloon.
Howey get here?
Out west, the Wahi brothers’ legal reps filed a motion with the District Court for the Western District of Washington to dismiss the civil charges brought against them by the U.S. Securities and Exchange Commission (SEC). The SEC’s charges were based on the regulator’s view that “at least nine” of the tokens involved in the insider trading scandal were unregistered securities.
The 81-page motion accuses the SEC of “trying to seize broad regulatory jurisdiction over a massive new industry via an enforcement action against a 32-year-old former Coinbase employee and his kid brother.” They claim this is “not how major questions of law that loom over entire industries should be resolved.”
From that dramatic opening, the attorneys attempt to debunk the SEC’s claims that most digital tokens meet the Howey test for identifying a security. The motion claims the Howey ‘investment contract’ stipulation doesn’t apply because “here there are no contracts, written or implied.” Token developers “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.’”
Next up is Howey’s ‘common enterprise’ requirement, via the claim that token purchasers “do not pool their assets together as part of some shared endeavor, and their fortunes are not tied to those of the original developers.” Token purchasers are “no different from when someone buys a baseball card on the secondary market.” Token value is “driven by market forces, not managerial efforts.” [Emphasis in the original.]
However, the argument loses some steam when it claims “each” of the tokens involved in the insider trading “is a ‘utility token’ – something that, by nature and design, is used on a platform rather than stored as an investment.” The motion further argues that the tokens “can operate without any centralized intermediary.”
Moreover, “the fact that any given set of developers may have retained the ability to affect a token’s price” apparently doesn’t meet Howey’s requirement that profits come from “the efforts of others.” That apparently “requires something more than merely having the capacity to influence a token’s price.”
The SEC has warned that tokens spawned from initial coin offerings (ICO) likely qualify as securities offerings that require registration. The Wahi attorneys argue that previous ICO cases hinged on the fact that the tokens were “pre-functional” and thus “required the ongoing efforts of the developers to become operational.” The tokens, in this case, “all exist on a functional blockchain” and thus “can be used, and buyers purchase them to use them.”
But the weakest plank of the motion is how these nine tokens can’t be securities because, well, Coinbase listed them. And Coinbase’s “entire business model is premised on not listing securities.” They go on to cite Paul Grewal’s infamous July 2022 blog post titled Coinbase Does Not List Securities. End of Story. As such, “there was no reason for Ishan Wahi to think” that any of the nine tokens were securities. This a bold claim, given Coinbase has been hit with nine-figure fines for ignoring other regulatory requirements.
Except, it’s not the end of story
The SEC has yet to reply to the Wahi brothers’ brief, but bear in mind that some of the tokens involved in this case have indeed been relentlessly promoted by their developers regarding their ability to create money-making opportunities for token buyers.
The SEC’s original complaint relates how “investors were told, explicitly or implicitly, that they could sell their securities in the secondary markets and that the liquidity available in the secondary markets could drive up the value of their crypto asset securities … each of the nine companies invited people to invest on the promise that it would expend future efforts to improve the value of their investment.”
For each of the tokens involved, the SEC offers examples of this shilling. For instance, consider PowerLedger’s communications regarding its POWR token. A 2017 Medium post claimed that “using a token model, there is now an incentive to be an early adopter or user of the network” because “demand drivers” in the future “may increase the value of POWR” tokens.
Following POWR’s listing on Coinbase, PowerLedger put a notice on its website celebrating how “POWR token skyrockets on Coinbase debut.” In doing so, the SEC says PowerLedger “directly linked its potential growth to POWR’s value for investors.” If that wasn’t enough, the PowerLedger website declared that “the greater the demand we create for POWR tokens, the more benefit accrues for POWR token holders.”
PowerLedger also went to great lengths to trumpet the centrality of its management team to the future of the company and, by extension, the value of the POWR token. And so on…
Security? Blank it!
The Wahi brothers’ motion echoed a familiar refrain among crypto bros regarding the SEC’s “Delphic strategy of revealing one-off securities via enforcement actions.” Like Coinbase, the attorneys claim they have no way of knowing what is and isn’t a security because the SEC hasn’t told them.
The SEC shouldn’t have to tell them. The Howey test has been around for three-quarters of a century. If the crypto bros still can’t tell what’s a security, it’s because they don’t want to know. In Coinbase’s case, wilful blindness—and the ability to go on listing speculative alt-coins and collecting trading commissions—is helping keep the company afloat as the once reliable influx of sucker money dries up.
Less partisan observers have long warned that no new laws or regulations were required to regulate the ‘crypto’ sector; the laws already on the books were quite applicable, thank you. Ignorance of the law—be it real or feigned—is still no excuse.
It’s worth noting that ten different attorneys signed the Wahi brothers’ motion from five different firms, some of them heavy hitters. Nine of these attorneys claimed to be representing Ishan, the ex-Coinbase staffer, but I think we can guess whose ass is really being defended here.
The SEC is reportedly investigating Coinbase on the unregistered securities front, a threat that must be taken seriously given the recent civil complaints filed against both Genesis and Gemini over their respective lending programs. Still, nothing that a sharply worded Grewal blog post probably won’t fix, we’re sure.
The SEC doubled down on its views Tuesday when it issued an ‘investor alert’ regarding self-directed Individual Retirement Accounts (IRA) and the associated risk of fraud. Self-directed IRAs “allow investment in a broader—and potentially riskier— portfolio of assets than other types of IRAs.” The list of these risky assets includes ‘crypto assets.’
The SEC warns that crypto assets “may be securities that are offered without SEC registration or a valid exemption from registration, and may not be accompanied by complete or accurate information to aid investors in making informed decisions. In addition, many of the trading platforms for these crypto assets refer to themselves as ‘exchanges,’ which may give investors the misimpression that they have registered with the SEC.”
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