Coinbase Says SEC May Sue To Stop Its Lending Program – Corporate/Commercial Law


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Coinbase Says SEC May Sue To Stop Its Lending Program


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On The Coinbase Blog, Chief Legal Officer Paul
Grewal stated that the SEC issued a notice to
Coinbase indicating the agency’s intention to bring an
enforcement action against Coinbase if it were to launch its
proposed Coinbase Lend (“Lend”) program. The program
would allow customers to lend USD Coin to Coinbase and earn
interest. (USD Coin is a dollar-based stablecoin
created by Coinbase.)

Mr. Grewal asserted that Coinbase’s Lend program is neither
an investment contract nor a note, so customers would not be
“investing” in the program, but rather
“lending” the USD Coin the customer already holds on the
platform. He said that the SEC appears to consider Coinbase Lend a
program that involves a security, under the Howey and Reves tests.

Mr. Grewal provided further background on Coinbase’s
interaction with the SEC, saying that Coinbase could have
“simply launched the product but [] chose not to,”
deciding to notify the SEC first. He said that after Coinbase
provided significant information to the SEC, the SEC simply stated
that the Coinbase Lend program involved a security and did not
provide further explanation as to its reasoning.

Separately, Reuters reported on Coinbase’s delayed
launch, noting that the SEC’s actions came after SEC Chair Gary
Gensler announced the agency is seeking more
authority to oversee crypto trading and lending.

Coinbase CEO Brian Armstrong said on Twitter: “If we end up in
court we may finally get the regulatory clarity the SEC refuses to
provide. But regulation by litigation should be the last resort for
the SEC, not the first.”

Commentary

Setting to the side the SEC’s alleged failure to explain
itself, the relevant legal precedent at issue here is not Howey; it is Reves (holding that demand notes sold to
retail investors are securities). The security at issue in this
case is not the USD Coin (which is probably not a security
at all); it is the loan of the asset to Coinbase. In short,
the SEC would almost certainly assert that Coinbase is offering
unsecured interest-bearing “notes” to retail investors;
the fact that the retail investors are purchasing those notes with
USD Coin rather than with dollars is likely not viewed by the SEC
as a differentiating factor. If one were to take the view that the
Coinbase Lend program did not involve a security, it would be the
simplest thing in the world to issue debt without becoming subject
to the securities laws: simply issue a dollar-based
stablecoin, then borrow back the stablecoin at an agreed interest
rate, and then convert the stablecoin back into dollars.

Put differently, while followers of developments in digital
assets may think that this matter casts a very negative shadow on
the distribution of digital assets, actually the relevant
legal analysis has nothing to do with digital assets (they are what
Hitchcock might have called a “MacGuffin”: they merely
make the story interesting). In fact, the legal analysis is just as
to whether Coinbase can borrow money unsecured from retail
investors without being subject to the securities laws. Stated
bluntly, a court is most likely to find that the answer is
“no.” The Coinbase Blog states that a number of
other businesses already have similar lending programs. Those other
businesses will now need to consider whether they are at risk.

Notwithstanding the likely outcome of resulting litigation,
the SEC owed Coinbase some explanation of its reasoning for
threatening the firm with enforcement action (that
is, assuming that Coinbase, at least by its own report, made
significant efforts to reach out to the SEC). The SEC should
view itself as primarily a regulatory agency, not a criminal
enforcement agency, and in that role it owes market participants
some explanation of its understanding of the law.

Primary Sources

  1. The Coinbase Blog: The SEC has told us it wants to
    sue us over Lend. We don’t know why.

  2. Reuters: U.S. markets regulator takes aim at
    Coinbase lending product

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