The cryptocurrency exchange Coinbase has submitted a response and a motion to dismiss the case filed against it by the U.S. Securities and Exchange Commission (SEC), addressing the regulatory agency's allegations of operating an unregistered securities exchange. In its response, Coinbase strongly asserts that the SEC's allegations lack merit and emphasizes that it underwent a thorough examination of its business practices by the SEC prior to going public. Coinbase's Chief Legal Officer, Paul Grewal, stated that the company never listed securities and that their token listing process was in full compliance with the SEC's review in early 2021. This response filing marks Coinbase's formal response to the legal dispute, signaling the beginning of a lengthy legal battle.

So what does Coinbase actually argue in these two legal documents? How do they argue that the tokens traded on their platform are not securities? This article outlines the key points in these two documents.

Coinbase's Motion to Dismiss

This motion, directly submitted by Coinbase to the presiding judge of the case, seeks the dismissal of the lawsuit. After briefly introducing the SEC's core allegations against Coinbase and its four main objectives—claiming that Coinbase engages in spot and institutional trading, securities brokerage, wallet custody, and staking services—the document directly addresses the central issue of the case: determining whether cryptocurrencies and staking services qualify as "securities" and whether Coinbase complies with the allegations. In the filing, Coinbase succinctly concludes: "[They (referring to cryptocurrencies and assets)] are not securities. Therefore, the case should be dismissed."

In terms of specific logical arguments, Coinbase systematically refutes the SEC's allegations based on the Howey case (the case that created the Howey Test).

It first points out that according to the definitions in the U.S. Securities Exchange Act and securities laws, the term "securities" includes "instruments commonly known as 'securities'," one of which is an "investment contract". This concept was established in the Howey case 77 years ago, where an "investment contract" refers to "any contract arrangement whereby one invests money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party". However, the transactions on the Coinbase platform and the Prime service do not fall under this type of contract. Instead, they are asset sales, where the obligations of both parties are fulfilled upon the delivery of digital tokens in exchange for money. Unlike stocks and other securities, when these tokens are traded on Coinbase, there are no statutory or contractual rights associated with them, such as dividends. Any purchaser on Coinbase cannot claim any rights beyond the acquisition of the tokens. Without this ongoing contractual relationship, the SEC's charges cannot hold.

In addition, regardless of any additional contractual expectations of Coinbase purchasers regarding the increase in the market value of their tokens, this does not constitute a claim to profits, assets, or management of the company. Classical securities can be simple shares, representing ownership of dividends and residual value of the company; preferred stock, with interest and liquidation preferences; bonds, notes, or other debt contracts providing fixed returns to investors; and investment contracts, where investors contribute funds in exchange for contractual requirements for corporate profits. However, there must be statutory rights to the company. Since the transactions on Coinbase do not involve such rights, they do not fall into the category of securities.

Even if the SEC presents a credible claim that the transactions involved here are "investment contracts", the "substantiality" doctrine requires the dismissal of the complaint. As Congress has expressly recognized the lack of delegated authority to regulate cryptocurrencies and is actively considering regulatory frameworks, the SEC lacks the power to exercise "clear congressional authorization" over this trillion-dollar emerging industry.

Similarly, the attacks on wallets and Coinbase's staking services do not hold ground. The SEC failed to allege that the tokens available in the wallets possess key features of investment contracts, and it did not recognize the wallet functions as "brokers" under securities laws. As for the staking feature, given the facts stated in the complaint, customers staking through Coinbase's software neither acquire shares of the enterprise through investment funds nor face loss risks by staking their own tokens, and they receive administrative rather than managerial services. Therefore, legally speaking, there is no investment contract.

This application was personally retweeted by Paul Grewal, the Chief Legal Officer of Coinbase, and also received a lot of attention on Twitter.

Coinbase's 177-page response to SEC's allegations

In this 177-page response, Coinbase refutes (or admits certain facts) each term in the SEC's filed complaint and further presents arguments and evidence proving the insufficiency of the SEC's allegations.

Argument 1: Comprehensive review by SEC during Coinbase's 2021 listing, but no objections raised by SEC at that time

According to the document, when Coinbase sought to list in April 2021, the U.S. Securities and Exchange Commission declared Coinbase's registration statement effective, allowing Coinbase's stock to be sold to millions of retail and institutional investors. This announcement was made "after months of extensive review and comments on Coinbase's registration statement." Coinbase opened up its business to the SEC, explaining its core operations such as listing, trading, staking services for digital assets, as well as self-custody wallet software, which were and still are the core aspects of Coinbase's operations. Based on its mission to consider "the public interest and investor protection," the SEC allowed Coinbase to go public without ever implying that Coinbase must register its operations.

Argument 2: SEC never classified digital assets as securities during the 2021 listing review

Coinbase mentioned that the SEC's lawsuit this year accuses Coinbase of failing to register as a national securities exchange, broker, and clearing agency since 2019. Based on these allegations, the SEC claims that out of the more than 240 tokens traded on Coinbase's spot exchange, 12 are considered "securities." At the time the SEC declared its registration statement effective, 6 of these 12 assets were already being traded on Coinbase. However, the SEC did not categorize any of them as securities in 2021.

Coinbase then states in the document that the SEC's change of attitude is not due to any substantial changes in Coinbase's business since 2021, nor does it mention any specific changes or new information. In its complaint, the SEC does not imply that Coinbase concealed anything during years of cooperative discussions before becoming a public company. This reversal also isn't due to legislative changes. Congress has been considering and continues to actively consider multiple regulatory proposals regarding digital assets, but since April 2021, no laws have been enacted that give the SEC the authority to regulate digital asset exchanges, let alone retroactive regulations. The only variation in the entire process is the SEC's stance on its own authority. Legally, this position is untenable, and asserting this position through enforcement action violates due process and the separation of powers principle in the U.S. Constitution.

Argument 3: SEC may not have the authority to regulate the cryptocurrency industry, and the lawsuit is excessive regulation

The document mentions that in May 2021, a few weeks after Coinbase went public, SEC Chairman Gary Gensler testified in Congress, stating that the commission lacks statutory authority to regulate companies like Coinbase. He stated that only Congress can address the regulatory gaps that commission officials have long recognized, "because there is no regulatory framework for trading these crypto assets at present." He also emphasized that "these crypto exchanges lack market oversight agencies."

Within the jurisdiction of the SEC, the assets traded on Coinbase's secondary market platform do not fall under the jurisdiction of the SEC because, contrary to the SEC's assertion, they are not "investment contracts" and therefore not "securities." Like all securities, the definition of an investment contract is only met when there is a continuing enterprise arrangement involving management with executable obligations to investors. Without such obligations, the contract is merely an asset sale.

Because Coinbase's secondary market trades do not carry such obligations and the value obtained by Coinbase purchasers through these trades is related to the physical goods bought and traded, not to the enterprise that generates these goods, these trades are not securities transactions. This understanding was reflected in Chairman Gensler's testimony in May 2021. It echoes a fundamental "regulatory gap" acknowledged by SEC staff in internal discussions made public in 2018 and the limitations of the SEC's authority in the realm of digital assets. Prior to the recent regulatory overreach by the SEC, no court had ever interpreted "investment contract" to apply to independent asset sales or arrangements where the seller does not operate the business for the benefit of the buyer.

Argument 4: Digital assets, wallets, and staking functionality are not securities; lawsuits are merely a result of SEC's expanded definition

Similar to Coinbase's motion to dismiss, this filing argues using the same logic why digital assets, wallets, and staking services are not securities and do not require registration.

Coinbase argues that the SEC has significantly expanded its definition of investment contracts, and thus expanded its regulatory authority over digital assets. It has done so by fiat, without justification, and without congressional authorization. Even as Chairman Gensler has advanced this agenda, Coinbase has repeatedly sought engagement with the agency to understand and address its new positions. Coinbase even submitted a petition for rulemaking to the SEC in July 2022 to clarify which assets the commission deems as securities. This petition remains unanswered.

Argument 5: Interpretive authority should belong to Congress, not agencies

Coinbase explanation, the SEC's claim of "securities" only applies to specific types of investment contracts. Although the SEC's explanation may have some reasonableness, the "major questions doctrine" requires rejecting that interpretation under the premise of respecting Congress's power to choose how to regulate "an important part of the U.S. economy". This is because the courts "presume that Congress intended to make the important policy decisions itself, rather than leaving them to agencies". When an agency claims to have discovered new powers over an important part of the U.S. economy in long-standing regulations, the court will not accept the agency's "novel" legal interpretation without "clear congressional authorization", even if the interpretation is "reasonable" or "plausible".

Argument 6: SEC needs to go through formal rulemaking procedures, not litigation, even if it has regulatory authority

Coinbase argues that even if the SEC has the necessary statutory authority, the agency's new interpretation of "investment contracts" needs to go through formal rulemaking procedures. Imposing so-called regulatory authority through punitive enforcement actions, instead of informing and soliciting comments through rulemaking procedures, is a violation of due process and an abuse of power by the agency, which is sufficient to reject the claimed right.

Faced with improper claims of authority by the SEC to fill existing regulatory gaps, federal courts have recognized the confusion caused by the SEC to market participants. As a court recently observed, "the regulatory agencies themselves appear unable to agree on whether cryptocurrencies are commodities that may be regulated by the CFTC, securities regulated under the securities laws, or neither, and even which standards should apply in making that determination." As another court recently asked, "why is it wise, from the Commission's perspective, to entrust such a far-reaching decision in an industry worth billions of dollars to a single federal district judge?"

In subsequent sections, Coinbase writes that the SEC chooses to advance its aggressive agenda through punitive retrospective enforcement actions rather than testing its new views through notice and comment rulemaking. The agency's enforcement power is important, but not unlimited. The SEC's actions here exceed those limits and should therefore be deemed unlawful.

Argument 7: SEC failed to provide Coinbase with any explanation and opportunity for collaboration, and chose to file a lawsuit directly

Coinbase illustrated this point with an example. On the same day that Coinbase submitted its application, the SEC filed a lawsuit against a 32-year-old former Coinbase employee and his brother - SEC v. Wahi, accusing them of "securities" fraud and using confidential information from Coinbase to make early purchases of nine tokens on the Coinbase platform. The U.S. Department of Justice did not claim in its parallel action that these tokens were securities. However, the SEC did so, and the lawsuit did not mention Coinbase or any issuer or developer of the tokens involved.

Therefore, the interaction between the SEC and Coinbase was not through any regulatory process, but through proxy litigation, leaving decisions about Coinbase's listing of assets, its extensive compliance efforts, and its years of interaction with the SEC to an unprepared, unsympathetic criminal (Wahi) who harmed the company. Faced with the defendants' motion to dismiss and filings from Coinbase and other friendly parties providing detailed support, these filings revealed that the lawsuit exceeded the SEC's statutory authority and violated due process (as Coinbase once again raised fundamental flaws in this case). In a settlement that was non-monetized and neither admitted nor denied, the SEC summarily ended the Wahi lawsuit. This partially implies that the SEC attempted to prove that tokens traded on Coinbase are securities through another completely unrelated case, without giving Coinbase any opportunity for explanation.

Coinbase believes that the SEC's enforcement approach is "retrospective accountability" rather than "prospective guidance," resulting in a series of other enforcement actions. As these actions increase, SEC Commissioner Hester Pierce points out that "using enforcement actions to tell people what the law is in emerging industries is unfair," and she observes that "one-size-fits-all enforcement and mechanistic analysis are not going to work."

Argument 8: Gary Gensler's contradicting statements

In December 2022, Chairman Gensler told a reporter that he believes the SEC has enough power to regulate digital asset platforms comprehensively. This is directly contrary to Chairman Gensler's previous acknowledgment that Congress has not authorized the SEC to regulate digital platforms. However, there have been no changes in the law during this 18-month period. Nevertheless, Mr. Gensler announced that digital asset platforms can and must "come in and talk to us and register" immediately. However, Coinbase has already met with the SEC dozens of times and has submitted applications to the SEC through rulemaking because there are currently no existing rules for regulating the registration of digital asset securities and digital asset exchanges. The SEC itself has stated that "the trading venues that the SEC regulates involve only securities." As some senior SEC officials have admitted, Bitcoin and Ethereum are commodities, not securities, so exchanges that trade both commodities and securities cannot be registered. This is also one of the reasons why Coinbase's listing process is designed to avoid listing assets that the SEC may designate as securities based on its previous statements.

Argument 9: Coinbase has repeatedly been denied by the SEC despite expecting cooperation

According to Coinbase's statement, in late 2022 and early 2023, Coinbase continued to cooperate with the SEC. In over ten demonstrations and more than 27 phone communications, Coinbase shared its views on the possible structure of a registered digital asset securities trading platform with the SEC, as well as the feasibility of trading securities and non-securities on a single platform. The planned meeting, which was supposed to be the first substantive response from SEC staff to Coinbase, was canceled by the staff the day before the meeting and Coinbase was informed that they would instead take enforcement action.

In March 22, 2023, SEC staff issued a Wells notice informing Coinbase employees of their intention to recommend enforcement action against the company. The Wells notice was issued while Coinbase was still providing documents to the SEC and after the staff had only taken testimony from two Coinbase mid-level employees. The SEC did not disclose the specific charges against Coinbase. During the Wells notice conference call, Coinbase directly asked: which assets traded on our platform are securities? The staff said they "have no way" of determining specific assets.

Argument 10: SEC's ambiguity in the previous request for a preliminary injunction in the Third Circuit

In the previous request for a preliminary injunction filed by Coinbase in the Third Circuit, the SEC's statements were completely contradictory. Coinbase claimed that the request for a preliminary injunction was made in the context of "facing imminent enforcement action, with uncertain scope and timing, and the SEC has yet to decide on the company's nine-month-old rulemaking petition, let alone provide any formal guidance on the basis for its institutional expansion of regulation."

Coinbase requested the Third Circuit Court of Appeals to order the SEC to "explain on the record whether it will initiate proceedings to establish rules regarding others and potential imminent charges against Coinbase." The reason for seeking assistance is clear: the SEC is enforcing new, previously undisclosed standards for regulating digital assets that contradict previous statements by SEC officials and Coinbase's DPO process. As part of proper administrative procedure and due process, Coinbase has the right to know the basis for the SEC's claim of newly discovered extensive authority, or to challenge the SEC in court if it refuses to provide it.

In response to the petition for a restraining order, SEC hesitated on May 15th, 2023. It stated that it did not "secretly decide to reject" Coinbase's petition. SEC told the court that Coinbase's proposals were "unfounded." However, in a public speech on the same day, Chairman Gensler expressed the opposite view that no additional guidance is needed as the rules have already been published.

Coinbase's lawsuit response legal document provides a detailed account of the company's position and views, claiming that it underwent a comprehensive review by the SEC before going public and that it complied with legal requirements and adhered to industry standards. This legal dispute will continue and may evolve into a long battle. The arguments from both sides will determine the boundaries and future development direction of the cryptocurrency exchange industry in relation to regulatory authorities.