Most crypto enthusiasts are less than pleased with the United States Securities and Exchange Commission’s past approach to crypto. This is not because legitimate businesses oppose regulation but because of the breadth, complexity and uncertainty associated with the current regulatory regime. Even in the context of general discontent, few actions by the SEC have engendered as much widespread criticism as the Dec. 22, 2020 complaint that initiated a civil enforcement action against Ripple Labs and two of its executives.
Not everyone opposed the action. For example, Coin Center, a pro-crypto nonprofit advocacy and research group, declined to argue against the idea that XRP is a security. In my previous Expert Take, I suggested that the case was consistent with prior SEC enforcement initiatives and the Howey investment-contract test, simply known as the Howey test, which has long been used by the SEC to determine when crypto assets are securities.
On the other hand, there are plenty of voices condemning the SEC’s case. This includes complaints by former SEC official Marc Powers, current SEC Commissioner Hester Peirce, and a pending lawsuit arguing that Ripple’s XRP token is not a security, in which thousands of XRP holders have sought to participate. The Regulatory Transparency Project, a nonprofit, nonpartisan group associated with the Federalist Society, sponsored a teleforum on June 24 titled “SEC v. Ripple Labs: Cryptocurrency and ‘Regulation by Enforcement.’” With a preenrollment of more than 500 members of the public, the audience was overwhelmingly unhappy (and unimpressed) with the SEC’s action against Ripple and its XRP token.
This general dissatisfaction with the Ripple case, often denigrated as “regulation by enforcement,” has led some to call for the development of a “Ripple test” to more clearly articulate how securities laws should apply to crypto assets.
Who is calling for a Ripple test?
The label of a Ripple test might have first been used in a specious post from Dec. 22, 2020 falsely claiming that the SEC was abandoning the Howey test in favor of an approach that reportedly required “new companies to operate for eight years to find out if what they’re doing violates securities law.” However, more thoughtful commentators have joined the call for a Ripple test to prevent businesses from operating for years without knowing whether they might be called into court for having run afoul of U.S. securities laws.
On May 18, Roslyn Layton, a senior contributor and well-respected technology policy writer for Forbes, publicly called for a Ripple test to “stop the SEC’s overreach on cryptocurrency.” Part of the overreach she identified was the SEC’s claim that it could initiate an action reaching back to sales that started more than seven years ago, potentially leading to a fine of billions of dollars. Layton’s response was that “those seven years have a broad public record of refusal by the SEC to provide any clarity over XRP.” She noted, convincingly, that during those years, the SEC declined to announce how it intended to treat Ripple’s XRP token.
Since the original piece in Forbes, several other commentators have joined the call for a “Ripple test.” One published opinion, authored by George Nethercutt Jr. — a former member of Congress — noted:
“Recent calls to establish a more appropriate standard for technologically complex digital assets have turned into a firestorm since the Ripple case was filed. Some tech policy experts closely following the case have called for a ‘Ripple Test’ to replace Howey.”
Curt Levey, president of the Committee for Justice — an organization devoted to advancing constitutionally limited government and individual liberty — also raised the Ripple test during the Regulatory Transparency Project’s June teleforum, noting that the need for a Ripple test is continuously evolving regardless of the outcome of the SEC lawsuit.
Existing approaches that might become the Ripple test
The difficulty, of course, is in fully explaining what a Ripple test might entail (other than not being the Howey test, of course).
The utility token approach
One possibility is to look at the functionality of the underlying asset, essentially resurrecting the utility token analysis. At one point, commentators made a concerted effort to distinguish between utility and security tokens. Unfortunately for entrepreneurs, as former SEC Chairman Jay Clayton noted, under the SEC’s approach, “Merely calling a token a ‘utility’ token or structuring it to provide some utility does not prevent the token from being a security.”
Some states, however, have adopted a utility token analysis to determine how such assets should be regulated. Not surprisingly, Wyoming, the most crypto-friendly state in the nation, enacted the “Wyoming Utility Token Act” back in 2017 — and passed two related house bills in 2019 — which allows issuers to proceed with tokens created for a consumptive purpose. In order to satisfy the requirements of this act, the predominant purpose of the token must be consumptive; the token cannot be marketed as a financial investment; and there either must be a reasonable belief that the token is sold to the initial buyer for consumption, the consumptive purpose must be available at or near to the time of the original sale, or the original buyer must be precluded from reselling the token until the consumptive use is possible. Tokens that comply with these requirements can be sold after the issuer files a notice containing specific but limited information with the secretary of state and pays a $1,000 fee to cover the costs of administering the statute.
Similarly, Montana has chosen to specifically exempt utility tokens (i.e., those with a consumptive purpose) from its securities laws. Section 30-10-105(23) of the Montana Code exempts utility token transactions from the registration requirements under state law. This provision requires the token to be designed primarily for consumptive purposes and not marketed for speculative or investment purposes. In addition, resales of the tokens are prohibited until the consumptive purpose is possible, and initial purchasers must acknowledge their intent to use them for the consumptive purpose. Colorado, through its Digital Token Act, has also chosen to exempt the issuance of tokens with a primarily consumptive purpose from the state’s securities laws.
While it would probably take an act of Congress to encourage (or force) the SEC to move in this direction, a Ripple test adopting the utility token (or consumptive purpose) approach could have precluded the application of securities laws to Ripple’s XRP tokens.
Excluding crypto assets that are regulated as virtual currency
An alternative Ripple test could limit the scope of the SEC’s authority under the securities laws so that an interest determined by the Financial Crimes Enforcement Network (FinCEN) to be a currency is not a security. In 2015, FinCEN and Ripple Labs Inc. made headlines with the announcement of the first enforcement action under the Bank Secrecy Act against a digital currency exchanger. As part of the release announcing the imposition of a $700,000 penalty against Ripple, FinCEN explained that the actions of the company were problematic because it had sold “its virtual currency, known as XRP,” without registering as a money services business.
This determination by FinCEN led commentators to widely speculate that XRP could not also be a security. There is certainly a logic to that position, as the settlement with FinCEN allowed Ripple to continue its operations and sales, which presumably should not have happened if the sales were illegal under federal law. Despite the existence of such commentary, the SEC remained quiet about how XRP should be regarded, even while its officials made public statements indicating first that Bitcoin (BTC) was not a security and then that Ether (ETH) was also outside the scope of securities laws.
Given this history, it is understandable that the decision of the SEC to initiate litigation against Ripple has been particularly polarizing. That decision could have been forestalled if the courts decided to remove digital currencies from the ambit of securities laws, or if the SEC reached that same conclusion.
However, those alternatives seem unrealistic, meaning that it would likely take an act of Congress to give the Department of the Treasury and FinCEN exclusive authority over digital currencies, thereby limiting the SEC’s authority. This approach could easily be identified as a Ripple test, as the impetus for this change is SEC vs. Ripple and the change would clearly preclude the SEC’s decision to act against Ripple and its XRP token.
A statute of limitations
A significantly more limited response, which could also be called a Ripple test, might involve something as simple as limiting how late the SEC can act after the commission becomes aware of the distribution of an interest it regards as a security. Even if the SEC was not fully aware or did not understand what Ripple was doing when it began marketing XRP tokens in 2012, clearly there was a general understanding of the company’s activities by 2015 when the FinCEN settlement was announced. Even so, the SEC did not initiate its enforcement proceedings until Dec. 22, 2020. It is this delay that has been the most widely criticized.
For claims by private plaintiffs under the Securities Act of 1933, Section 13 requires that the suit be initiated within one year of the violation as to that particular person and in no event more than three years after the security was first offered to any purchaser. This is a reasonable balance between the need of purchasers to obtain redress and some need for eventual certainty and closure for the issuer. However, the federal securities laws currently provide no statute of limitations on the right of the SEC to initiate enforcement actions. Presumably, it will take an act of Congress to amend the law to limit the SEC’s authority to act, but the very fact that the SEC has been willing to sue Ripple for decisions and actions initiated more than seven years earlier suggests that such action could be justified.
Problems with existing approaches
There are some obvious benefits to a Ripple test, not the least of which would be to remedy what is seen by many as a serious overreach by the SEC. Increased certainty would also be a sizable benefit to legitimate crypto entrepreneurs, but there are some problems with each of the approaches identified above.
First, a test that is focused on whether a particular crypto token has utility (or consumptive value) in order to determine whether or not the asset in question is a security may leave members of the public with inadequate remedies in the event that there is fraud. An alternative to saying that utility tokens are not securities would be to provide a simple exemption from registration for utility tokens. This would at least allow the anti-fraud provisions of the securities laws to continue to apply. A problem with saying that utility tokens are exempt is that it might be too easy for issuers to evade applying the securities laws by pretending that tokens are being sold for a consumptive purpose when the real hope is that they will be bought by speculators, pushing the price up.
In addition, it is likely to be difficult to determine whether the purpose of a token is “primarily” consumptive or whether it was really marketed as an investment rather than on the merits of its promised utility. Each of these are reasons that using a straight-forward utility test as the Ripple test might be problematic.
There are also problems with saying that an interest cannot be a security if it is regulated as a currency by FinCEN. First, FinCEN does not regulate to protect against fraud in the sale of interests, so this approach could easily leave members of the public who are scammed without a remedy. Because federal agencies are protective of their jurisdiction, this approach could also produce a race to regulate, which might not lead to the optimal results.
Alternatively, if FinCEN has the ability to determine that a crypto asset is a digital currency even after the SEC has acted first, this could lead to the very kinds of uncertainty and inconsistency that crypto entrepreneurs protest against under the current system. Because the mission of FinCEN is so different from that of the SEC, there would seem to be good reasons for allowing both to retain some jurisdiction in the space.
Finally, there are also some issues around setting a strict statute of limitations for enforcement actions. The SEC has limited resources, and when a new class of assets arises, it takes time to understand what those assets entail. It may have taken the SEC a considerable time to figure out exactly what was going on with XRP tokens precisely because they do have some utility and they work in an extremely complicated space. It is difficult to know what statute of limitations would be fair, and if the issuer in question (or its affiliates) continues to sell the asset, the SEC could still have jurisdiction over more recent sales, leading to the anomalous situation where some sales cannot be attacked while other sales are treated as illegal.
An alternative approach
The preceding discussion raises the question of what alternative approaches might work better. First, because it is absolutely clear that there are bad actors in the crypto space, it is important to have an active federal regulator that can intervene when members of the public are defrauded. The SEC has the resources and experience to enforce the anti-fraud provisions of the securities laws. This can be accomplished without the problems that are exemplified by SEC vs. Ripple if the regulatory approach is changed to recognize a broad, consistently applied exemption from registration for offerings that meet certain requirements.
The most obvious requirement for such an exemption is that it should be limited to issuers that are not subject to a stop order and have no past history of securities violations and that have no affiliates or control persons that have been convicted of a felony or fraud in the recent past. A “bad actor” disqualifier already appears in other exemptions, so it would not be unusual for this to be included in a new crypto transaction exemption.
Second, it makes sense for any issuer to have to notify the SEC of a planned sale or distribution of crypto assets. The notice does not need to include a huge amount of information, but it should include such things as the terms of the issuance, the consideration that they are paying and the general terms and functionality of the asset specifically including the rights that purchasers are acquiring as a result of ownership of the asset. In addition, not only does the SEC need information about the general terms and functionality of the blockchain on which the crypto assets are issued, that same information needs to be publicly available at the time of issuance. The information that must be readily available should include the quantity of assets authorized, the number that are controlled by the issuer or its affiliates or control persons, and the general conditions that must be met before assets are issued or the issuer can sell the assets as well as any limits on resale.
It might also be appropriate to have reasonable restrictions on the nature of the underlying program. One substantive requirement that makes sense is that the issuer should not have the unilateral right to modify the terms of the underlying blockchain or programming. It also makes sense to require that the crypto assets be designed with a consumptive purpose and that the tokens should be functional at the time of the sale. (Absent a consumptive purchaser, the only likely justification for purchase is speculation on future profitability.) Similarly, the proceeds of the sale should not be needed or intended to support development of the token’s functionality (provided that the general assets of the issuer may be used to support additional or improved functions, even if part of those assets are derived from the sale of the crypto assets). This is also intended to ensure that the tokens are being purchased because of the intended functionality rather than in the hopes that the issuer’s efforts will increase their value as an investment. As an alternative to this approach, it could also be acceptable if the functionality of the asset is intended to be available reasonably quickly and that resale by initial purchasers is precluded until such functionality develops.
Another requirement should be that the issuer specifically avoids selling the token by promoting the possibility of appreciation or profitability, or otherwise as a speculative investment. Finally, to avoid the possibility that this exemption is used to evade the securities laws, the asset should not give the purchaser a right to any share of or interest in the management, profits or assets of the issuer and must not be created primarily to evade application of the securities laws. These restrictions seem necessary to limit the new exemption in a reasonable manner while still offering a broad-based exemption for many assets.
These suggestions may be just another version of a Ripple test, they may be seen as a modified utility token test, or they may be regarded as something else. Regrettably, given the SEC’s actions to date, it will probably take an act of Congress to move regulation in this direction. Nonetheless, the need for a clearer, more reasonable path to regulatory compliance is illustrated by SEC vs. Ripple, where no fraud is alleged, yet the SEC waited to bring an enforcement action for more than seven years after the company began selling its token.
This article is for general information purposes and is not intended to be and should not be taken as legal advice.
The opinions expressed are the author’s alone and do not necessarily reflect the views of Cointelegraph nor the University of Arkansas School of Law or its affiliates.
Carol Goforth is a Clayton N. Little professor of law at the University of Arkansas, Fayetteville, School of Law.
El Salvadorians take to the streets to protest Bitcoin law
Protesters calling themselves the Popular Resistance and Rebellion Block have come out against El Salvador’s government passing a law making Bitcoin legal tender.
A Tuesday tweet from local news outlet El Mundo shows El Salvadorians carrying banners saying “no to Bitcoin” in the streets of San Salvador demanding a repeal of the country’s Bitcoin law. Legislative assembly members Anabel Belloso and Dina Argueta addressed the protesters after first meeting the group separated by a barrier of razor wire.
RT @SusanaPenate: Miembros del Bloque de Resistencia y Rebeldía Popular llegaron a presentar una propuesta de derogar la Ley Bitcoin. Salen a recibirlos Dina Argueta y Anabel Bellosopic.twitter.com/CXFLDW4tsr
— Diario El Mundo (@ElMundoSV) July 20, 2021
In a letter made available at the protest, the Popular Resistance and Rebellion Block group claimed that President Nayib Bukele passed the law making the cryptocurrency legal tender in the country without proper consultations with the people. It also cited the volatility of Bitcoin (BTC), comparing investing in the cryptocurrency to playing the lottery: “betting on the lottery is a voluntary act, while Bitcoin is required by law.”
Related: Coercion and coexistence: How El Salvador’s Bitcoin Law may change global finance
However, the group’s main grievance around the Bitcoin legal framework seemed to be centered around a perceived disparity in the cryptocurrency’s usage by the government when compared with the average resident in El Salvador. Protesters said Bitcoin “only serves some large businessmen, especially those linked to the government, to launder ill-gotten money.”
“Entrepreneurs who put their capital in Bitcoin will not pay taxes on their earnings,” said the letter. “In addition, to apply Bitcoin the government will spend millions of dollars of the taxes paid by the people.”
“Bitcoin would facilitate public corruption and the operations of drug, arms and human traffickers, extortionists and tax evaders. It would also cause monetary chaos. It would hit people’s salaries, pensions and savings, ruin many MSMEs, affect low-income families and hit the middle class.”
Though passed by El Salvador’s government and signed into law by Bukele in June, the law recognizing Bitcoin as legal currency in the country will not go into effect until Sept. 7. The Popular Resistance and Rebellion Block’s protest was aimed at government officials to demand the law be repealed. In addition, the World Bank has also refused to help El Salvador transition to a Bitcoin-friendly framework, given its “environmental and transparency shortcomings.”
Related: What is really behind El Salvador’s ‘Bitcoin Law’? Experts answer
During a scheduled visit by the U.S. State Department earlier this month, Under Secretary of State for Political Affairs Victoria Nuland suggested El Salvador ensure Bitcoin is well regulated and transparent, but did not explicitly say anything against the country’s move to a more digital economy. Some proponents of the law including Bukele have suggested Bitcoin could help facilitate remittance payments from El Salvador citizens living abroad and lessen the country’s reliance on the U.S. dollar.
Nonfungible tokens from a legal perspective
A nonfungible token (NFT) can be both a representation of a physical or digital asset that only exists on the internet — a programmable piece of art. It provides ownership of an underlying asset, like a painting, and it can also represent a digital asset in the form of a software code. Therefore, I like to conceptualize NFTs in a more technical view:
“An NFT is a pattern of smart contracts that provides a standardized way of verifying who owns an NFT, and a standardized way of ‘moving’ nonfungible digital assets.”
Before discussing the legality of an NFT, it is necessary to check what nonfungible tokens mean digitally. In its most general sense, an NFT is the digital representation of a nonfungible asset in the form of a serial number. Take a look at the image below.
In this article, I will try to point out numerous legal and judicial issues related to how a serial number can represent an asset on digital media and what is included in that code. It is important to keep in mind that, in addition to showing the property of a nonfungible asset, an NFT also indicates where the content of that asset has been located since its inception.
Related: How the NFT market leveraged blockchain tech for explosive growth
Owning an NFT
Is owning an NFT different from owning the rights of the underlying asset that compounds it?
In our current society, we are used to a piece of paper indicating or representing property rights and some work. We all have had contact with such kinds of papers in our daily lives: a deed to a property, a certificate of vehicular ownership, or a lease to a house. We already understand the value of these legal pieces of paper. That could be a good way of looking at NFTs as well, although there are some differences regarding the rights linked to them.
Related: Hybrid smart contracts will replace the legal system
There is a generalized perception that an NFT is an original asset itself. But is that perception correct? Wouldn’t an NFT be a receipt of owning a determined asset? As with everything else in the world of law, the correct answer is: it depends. It depends on what kind of underlying asset the NFT represents. An NFT can either be the original asset or an asset that only exists in the digital virtual world, like CryptoKitties or CryptoPunks. At the same time, an NFT can be the receipt confirming that you own a determined asset in the real world, such as real estate, or a physical piece of art exhibited at the Louvre Museum in Paris.
With that in mind, let’s go forward and discuss the problems that exist for internet-era creators that could be solved by registered NFTs via blockchain technology.
How does blockchain help the creators of content represented by NFTs?
Since the advent of the internet and peer-to-peer (P2P) networks, the content creators and the industry of intellectual property have been looking for a way of turning an asset, copyright protecting it and proving its scarcity and property in a digital realm. It was necessary to have a registering system that could provide immutability and precedence, while proving scarcity on the internet. But that became only possible after the double-spending problem which was solved by the invention of blockchain technology.
Related: How NFTs, DeFi and Web 3.0 are intertwined
An NFT registered via blockchain turns the content marketed on the internet immutable and unique, allowing artists to protect their creations from falsification and duplicity in the digital realm. Thus, blockchain-registered NFTs solve the problems of digital piracy and high costs of financial intermediation, among others, making a new type of economy feasible. One that is governed not by the traditional trust validators, but by those who produce and create value.
What rights are necessary for a person to create or coin an NFT?
That is a very up-to-date question. This spring, DC Comics sent a notice for artists involved in the creation of their superheroes comics prohibiting the commercialization of the art with their characters, including the digital production of NFTs. Probably, the news about the former DC comic artist, José Delbo, making $1.85 million for auctioning NFTs depicting the popular fictional heroine Wonder Woman got the company’s attention, leading to such a reaction.
The reason for the question raised in this section is simple: Not all artists and creators own the copyrights to their work. Usually, artists don’t need to worry about the rights of property or copyrights of their works, as they are the creators. Initially, they already hold everything we know in the world of intellectual property and the whole idea of rights. However, the general practice of the creator economy is that the rights to a work of art, music, etc., are allocated to several different parts: One part may hold the rights of distribution, another part has the exhibition rights, one other controls the performance rights, and another one owns the marketing rights.
What if you create an NFT of the work — with copyrights allocated to everyone involved — the reasonable question will be: Which of these rights holders would have the appropriate legal status to do so? Can each of the parties involved do this unilaterally, without the other right holders? That will take a lot of time to solve, both judicially and legally. Meanwhile, as the hype of NFTs is very recent and is still in development in many different sectors — such as music, games, physical art industries and the recently created programmable art — those legal issues are yet to be solved.
Related: Beyond the hype: NFTs’ actual value is still to be determined
Who has the right to coin NFTs? What exactly does that mean? While blockchain technology and decentralized marketplaces evolve in parallel, those questions will probably be the object of judicial demands and will be decided case by case. For now, it seems impossible to create universal legislation that encompasses situations in constant change.
There is still too much confusion in the NFT space, not only about which rights the creators are assigning, but also what the buyers are purchasing with the NFTs. The judicial analysis gets even more complex, especially when we talk about the property of NFTs, which includes several authors and their copyrights.
Another point to consider is how platforms have issued the terms of content and how content-intermediate companies deal with NFTs. The majority of those intermediate companies between the content creator and the NFT buyers need to do their judicial work by applying reasonable diligence when they build those platforms.
This gets more complicated when there is co-authorship in a determined creation, especially when the owners of the copyrights for those creations are companies. Will the NFTs be translated to protect intellectual property portfolios owned by those companies, and if yes, then how exactly?
What rights does the purchase of an NFT give to the buyer?
When an NFT is purchased, there are three parties that must be considered: the author of the original work, the creator of the NFT and the buyer of the purchased NFT. First, I need to underline that owning an NFT doesn’t mean obtaining the property of the underlying asset, but rather only getting the property of the NFT.
Nevertheless, as NFTs exist in digital media with no borders and in several jurisdictions simultaneously, or even where legislation is practically nonexistent, it is imperative for the platforms listing NFTs to specify the terms. And, with the terms, I mean that I hope they are included in their smart contracts to define which rights the NFT buyers are receiving from the creators.
Here, it is interesting to know that you are not obtaining ownership of the asset itself, nor even getting the intellectual property rights of that work. And, in this sense, the reasoning is no different from the acquisition of a physical piece of art in the traditional market. If a traditional painting in an auction is bought, the buyer does not receive the intellectual property rights of the asset itself. The buyer has the right to hang the new painting on their wall, but not the intellectual property of that painting, unless it has been commissioned. Therefore, it is not allowed to make posters of that painting on the wall. No one can’t create nor change it.
To sum it up, by purchasing an NFT, one is only receiving the rights to the bought NFT, the ownership rights to brag about having some connection to that work. But one does not have the intellectual property rights to use that work — no one has the right to copy, distribute or execute it, unless of course, such rights have been designated. Thus, the legal analysis of an NFT is very similar to what it would be with traditional intellectual property rights as if there were no NFTs at all.
How to determine the jurisdiction of an NFT?
Hypothetically speaking, imagine that copyright in France is perpetual (meaning that it lasts forever), it expires with the author’s death in the United States and that Canada protects copyright for 50 years after the author’s death. When the NFTs are registered in decentralized blockchain networks, what will the jurisdictional approach be? Which laws will be applied? For a completely decentralized platform that is distributed all over the internet, which rights should be applicable?
Will the jurisdiction be based on where the original artist lives, or could the jurisdiction be applied between the platform and the creator of the NFT? In any event, we will probably see many jurisdictional issues coming up, especially when dealing with something at early development and in progress.
We are still in the Wild West of regulating the emerging technologies, and the current difficulty with identifying how the NFT market will go through the paths of legal protection explains what is currently going on.
How can one identify the parts’ intention when dealing with those new rights if they are different? Will NFTs be considered a new base on what already existed and was contracted? Or will they be considered something that the previous agreements did not contemplate, which has the potential to generate more income?
Can someone take ownership of something that already exists to create something that will be designated as an NFT? Can someone take ownership of the NFT without the consent of the owner of the copyrighted work?
This article aimed not to deplete the subject, but only to bring some considerations and ideas regarding the legal aspects of nonfungible tokens. NFTs under the juridical and legal perspectives are still evolving, and the ways to solve the legal issues and judicial disputes that will arise have yet to be considered.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Tatiana Revoredo is a founding member of the Oxford Blockchain Foundation and is a strategist in blockchain at Saïd Business School at the University of Oxford. Additionally, she is an expert in blockchain business applications at the Massachusetts Institute of Technology and is the chief strategy officer of The Global Strategy. Tatiana has been invited by the European Parliament to the Intercontinental Blockchain Conference and was invited by the Brazilian parliament to the public hearing on Bill 2303/2015. She is the author of two books: Blockchain: Tudo O Que Você Precisa Saber and Cryptocurrencies in the International Scenario: What Is the Position of Central Banks, Governments and Authorities About Cryptocurrencies?
Coinbase and top execs face securities class action over Nasdaq listing
A Coinbase shareholder has filed a securities class action against Coinbase for allegedly misleading investors ahead of its public listing about the company’s financial state and resilience as a crypto trading platform.
Filed by law firm Scott + Scott in California Northern District Court on Thursday, the class action names Coinbase shareholder Donald Ramsey as a plaintiff, both individually and on behalf of all other investors similarly situated.
Ramsey is pursuing his claims under the United States Securities Act and has presented evidence drawn from Coinbase’s regulatory filings with the Securities and Exchange Commission (SEC), company press releases, analyst reports and other publicly disclosed information about the exchange.
Alongside the company itself, the class action names CEO Brian Armstrong, CLO Paul Grewal and other top executives as defendants, as well as several of its venture capital backers.
Ramsey accuses Coinbase and its executives of making “materially misleading statements” in their offering materials at the time of the public listing and offering positive statements that “lacked a reasonable basis.” The class action alleges that:
“At the time of the Offering: (1) the Company required a sizeable cash injection; (2) the Company’s platform was susceptible to service-level disruptions, which were increasingly likely to occur as the Company scaled its services to a larger user base.”
Ramsey further alleges that once the alleged discrepancies between self-presentation and reality came to public light, Coinbase’s share price fell accordingly. Citing events in mid-May, when Coinbase conceded it needed to raise funds and announced plans to raise $1.25 billion through a convertible bond sale, Ramsey emphasizes that the company’s stock sharply declined by close to 10% over two trading sessions.
The class-action marshals evidence from contemporary media reports in mid-May, citing a Forbes’ report on the bond sale announcement:
“Investors were also likely surprised by the timing of the issue, considering that Coinbase just went public in mid-April via a direct listing (which doesn’t involve issuing new shares or raising capital), signaling that it didn’t require cash. So the company’s decision to issue bonds a little over a month later is likely raising some questions.
Ramsey’s class action also points to the technical difficulties on the platform on May 19, when a surge of traders hoping to “get their money out” during a bearish period in the crypto markets experienced “delays […] due to network congestion.”
As Cointelegraph reported at the time, delays in Ether (ETH) and ERC-20 token withdrawals ostensibly due to congestion on the Ethereum network were experienced that day by users on both Coinbase and Binance. While not indicating the reason, the Gemini exchange also announced that it would be taking emergency maintenance actions to correct ongoing issues.
Related: ETH developer Virgil Griffith back in jail after allegedly checking Coinbase account
The class action argues that these kinds of service-level technical issues are critical and damaging for the company’s claims to be the easiest place to buy and sell crypto in the retail market. The complaint emphasizes this all the more so, given that the company is reliant on transaction fees to “generate nearly all of its revenues.”
By the time Ramsey commenced the class action, Coinbase stock was trading at $208 per share compared to its opening price of $381 on April 14.
Counsel for the defendants had reportedly not yet appeared as of Thursday. Cointelegraph has reached out to Coinbase representatives for comment and will update this article accordingly.
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