Ex-Coinbase Manager Tests If SEC Crypto Reach Is ‘Major’ Question

The Securities and Exchange Commission will wrangle with the question of whether regulating a crypto token is a “major” issue, seeking an answer that could help define how the controversial products are policed.

The agency has sued Ishan Wahi, an ex-Coinbase manager, and his brother for alleged insider trading involving tokens listed on Coinbase’s platform.

The SEC says it has jurisdiction because several tokens are securities. But the defendants argue regulating digital tokens is a major issue. The SEC’s power grab violates the “major questions doctrine” that says an agency can’t bring about a major policy without clear statutory authorization, they say.

Last week, the Wahi brothers have asked a judge in the U.S. District Court for the Western District of Washington to dismiss the SEC’s case.

SEC v. Wahi promises to be closely watched, as it’s first case that directly asks a judge to weigh the major questions doctrine in a crypto matter. If the Wahis’ arguments were to gain traction in the courts, the scope of the SEC’s existing ability to police the massive crypto markets could become clearer.

“If the court agrees with the defendants here and grants the motion to dismiss, this will be one of the first cases of this magnitude,” Rutgers Law School professor Yuliya Guseva said. “It will have broad implications in future cases.”

Ishan Wahi last week pled guilty to criminal wire fraud charges brought by the Justice Department in connection with the scheme. His brother, Nikhil Wahi, was sentenced in January to 10 months in prison for his role.

The DOJ “did its job in holding this individual accountable” Coinbase’s chief legal officer, attorney Paul Grewal, wrote in a LinkedIn post after Ishan Wahi’s plea. Still, “atrocious personal behavior shouldn’t result in atrocious regulatory overreach that is contrary to law,” Grewal wrote.

Major Issue

The “major questions doctrine” requires clear authorization from Congress if an agency wants to decide an issue of major significance. The Supreme Court endorsed the doctrine in West Virginia v. Environmental Protection Agency, a 2022 decision involving a regulation to curb power-plant emissions.

“The Supreme Court has made pretty clear that it doesn’t think Congress grants sweeping authority over major issues hiding in ambiguous text or a footnote,” Jenner & Block LLP attorney Kayvan Sadeghi said.

There are two prongs to the major questions doctrine. A court first considers whether the agency is claiming authority over an issue of “major economic and political significance.” Then, it considers whether Congress has clearly authorized the agency’s action.

The issue of how to regulate crypto tokens is arguably a “major” question, lawyers and academics say.

It’s a $1 trillion industry that’s attracted investment from millions of people. President Biden in March 2022 called on federal agencies to coordinate an approach to the crypto markets.

Congress has considered crytpo-related legislation, and lawmakers held hearings after the stunning collapse of bankrupt FTX Trading Ltd., the defunct cryptocurrency exchange and hedge fund.

“This is clearly a major issue of our time,” Florida International University College of Law professor Jerry Markham said.

Power to Act

The more difficult question for the Washington court could be whether Congress has already clearly authorized the SEC to regulate digital assets.

Securities laws give the SEC the power to regulate “investment contracts,” and the SEC has taken the position that most crypto tokens fall under the category.

The Wahi brothers argue the agency is contorting the term and applying it in a new way that “massively” expands the agency’s power.

“It is hard to fathom a more archetypal violation of the Major Questions Doctrine than the SEC’s assertion of authority over digital assets,” the brothers wrote as part of a dismissal motion filed last week.

To determine whether something is an investment contract, courts and regulators use a test derived from a 1946 Supreme Court decision, SEC v. W.J. Howey. Although it’s a flexible test, there’s no indication Congress intended “investment contract” to be a catch-all phrase, nonprofit law firm Investor Choice Advocates Network said in an amicus brief filed Monday supporting the Wahis.

“The SEC nevertheless claims—as the EPA impermissibly did—to have discovered ‘an unheralded power’ which would vastly transform and expand its regulatory authority,” ICAN wrote.

Critics of the SEC’s approach say the agency misunderstands the Howey test. That test is designed to look at transactions—not objects like crypto tokens, lawyers and academics have argued.

Howey involved land sales with promises to manage orange groves. Courts have also found investment contracts in cases where breeders sold beavers and promised to raise them for fur, or when chinchillas were sold with an agreement to rebuy the babies.

“But that doesn’t give you the right to control the entire secondary market in oranges and beavers and chinchillas and tokens,” Sadeghi said.

By jumping from an analysis of the transaction to a conclusion about tokens, the SEC is exceeding the law’s boundaries and triggering the major questions doctrine, said Sadeghi.

Some of the crypto-related bills Congress has considered were aimed at clarifying that the SEC lacks jurisdiction over broad swaths of digital assets, the Wahi brothers said. This underscores that the SEC is overstepping its authorization from Congress, they say.

An attorney for the Wahis declined to comment.

No Change in Law

The SEC has ramped up enforcement action in the crypto space, and already has won a handful of court decisions.

The Wahi case is unique because it puts the distinction between transactions and tokens directly at issue, attorneys said.

Republican SEC commissioner Hester Peirce acknowledged the difference when she said in a speech last month that SEC references to crypto tokens as securities involves an “imprecise application of the law.” The agency likely needs “more, or at least more clearly delineated, statutory authority to regulate certain crypto tokens,” Peirce said.

Still, some legal scholars are skeptical that the “major questions doctrine” fits this context.

West Virginia v. EPA involved a new rule limiting greenhouse gas emissions from power plants, which was projected to have billions of dollars in compliance costs. Here, what’s being challenged is the SEC’s application of long-standing Supreme Court precedent.

“The problem with applying that doctrine to the SEC is that they haven’t made any rules,” University of Arkansas law professor Carol Goforth said. “They haven’t changed the law in one whit.”

The case is Securities and Exchange Commission v. Wahi et al, W.D. Wash., No. 22-cv-01009.