(The opinions expressed here are those of the author, a

columnist for Reuters.)

By Alison Frankel

March 5 (Reuters) - The U.S. Securities and Exchange

Commission scored a big victory in a small enforcement action

last Friday when a federal judge in Seattle granted a default

judgment against a no-show defendant accused of trading crypto

tokens based on insider information he obtained from a

since-fired Coinbase employee.

The agency is now hoping to leverage that win in its vastly

more consequential case against Coinbase itself.

You need a bit of background to understand the SEC's

maneuver. The commission's enforcement action against Coinbase,

as you probably recall, asserts that the crypto exchange

facilitated trading in at least 13 digital tokens that should

have been registered as securities but were not.

The SEC's theory is that the tokens are subject to its

oversight because they are investment contracts - and thus

securities - under the U.S. Supreme Court's longstanding Howey

test.

Coinbase and its lawyers at Wachtell, Lipton, Rosen & Katz

and Sullivan & Cromwell insist that Coinbase-traded tokens are

not investment contracts because, among other reasons, crypto

trading in secondary markets does not involve any contractual

promise that sellers will deliver future value nor any common

enterprise to boost profits.

Coinbase maintains that digital tokens are like Beanie

Babies or baseball cards - entities that are traded in

decentralized markets with the hope that they will appreciate in

value but are not securities.

The SEC and Coinbase are waiting for a make-or-break

decision on Coinbase's motion for judgment on the pleadings.

U.S. District Judge Katherine Polk Failla of Manhattan heard

four hours - four hours! - of oral argument in January, but my

Reuters colleagues who listened to the argument reported that

the judge said she still hadn't made up her mind about whether

tokens are digital assets.

The SEC seems to counting on the Seattle judge's decision to

help persuade Failla.

On Monday, the agency informed Failla that U.S. District

Judge Tana Lin of Seattle concluded in the Coinbase insider

trading case that the tokens allegedly purchased with insider

info were indeed investment contracts, even though defendant

Sameer Ramani traded the assets on a secondary exchange and not

directly with issuers. (Ramani, who has allegedly fled the

country, did not appear in the SEC proceeding, which also named

former Coinbase employee Ishan Wahi and his brother Nikhil Wahi

as defendants.)

As the SEC told Failla in Monday's letter, Coinbase was

among the amici that filed briefs in the Seattle case arguing

that exchange-traded tokens are not securities. The agency said

Lin's ruling to the contrary was particularly notable in light

of those amicus arguments, including by Coinbase.

Before I explain Lin's reasoning, I should note that

Coinbase responded to the SEC's letter with its own letter to

Failla on Tuesday, arguing that neither the exchange nor any

other amicus filed a brief opposing the SEC's motion for a

default judgment against Ramani.

Coinbase said its amicus filing in the Seattle case

addressed a separate motion by Ramani's co-defendants, the Wahi

brothers, to dismiss the case. That hotly contested motion,

Coinbase said, was never decided because the Wahis settled with

the SEC after pleading guilty in a parallel criminal case.

Coinbase urged Failla therefore to give no weight to last

week's Ramani decision. Lin's opinion, it said in quite pointed

language, "was procured against an empty chair and its reasoning

reflects as much."

A Coinbase spokesperson declined to comment, but the

exchange's legal chief, Paul Grewal, addressed the Lin decision

in a series of posts on X on Monday. Grewal said that as a

general rule, default judgment opinions don't have much sway

with other courts. He also asserted that Lin based her ruling

only on the SEC's default judgment brief, without considering

Coinbase's amicus brief on the investment contract issue.

So why did Lin conclude exchange-traded tokens are

investment contracts? Under the three-prong test derived from

Howey, she said, in order for a financial instrument to be

deemed an investment contract, it must involve an investment of

money in a common enterprise with an expectation of profits

produced by the efforts of others.

The first prong, Lin said, was easy in this case: Ramani

bought tokens. On the second prong, Lin found that the SEC

adequately alleged a common enterprise among buyers and token

issuers that promised to manage and develop their businesses for

the collective benefit of token-holders.

"Investors' fortunes were all equally dependent on the

success of the same common enterprise - maintaining the value of

tokens collectively and nurturing the development of the

cryptocurrency ecosystem," Lin said.

Lin similarly found that token purchasers were surely

persuaded to expect profits by issuers' promotions and promises.

It didn't matter, she said, that Ramani bought crypto tokens on

the secondary market, and not directly from issuers, because

"each issuer continued to make such representation regarding the

profitability of their tokens even as the tokens were traded on

secondary markets," the judge said.

Lin cited two 2023 decisions concluding that tokens are

securities: a summary judgment ruling in the SEC's case against

digital media company LBRY and a summary judgment decision by

U.S. District Judge Jed Rakoff of Manhattan against now-bankrupt

stablecoin issuer Terraform Labs.

The Seattle judge, however, did not cite another

high-profile 2023 crypto decision, a summary judgment ruling by

U.S. District Judge Analisa Torres of Manhattan in the SEC's

case against XRP issuer Ripple. Torres, as you may recall, held

that Ripple's sales to retail investors on secondary crypto

exchanges were not securities transactions.

You probably won't be surprised to hear that Coinbase's

letter on Tuesday to Failla highlighted Lin's omission of the

Ripple decision from her default judgment ruling.

The SEC declined to comment on Coinbase's letter to Failla,

citing the ongoing litigation. In a statement, the commission

hailed Lin's holding in the Wahi case that "crypto asset

transactions in secondary markets can be transactions in

securities."

The back-and-forth between the SEC and Coinbase over Lin's

decision is in one sense just a minor skirmish in their

multifront war. But the intensity on both sides tells you a lot

about the stakes in this litigation.

Read more:

Coinbase, SEC lock horns in US court over crypto securities

Terraform Labs must face US SEC fraud allegations, judge

rules

Ripple Labs notches landmark win in SEC case over XRP

cryptocurrency