In a rare move, U.S. District Judge Katherine Polk Failla of the U.S. District Court for the Southern District of New York granted Coinbase’s request for authority to pursue an interlocutory appeal on Tuesday to the U.S. Court of Appeals for the Second Circuit on whether cryptocurrency transactions can be classified as investment contracts under federal securities laws.
“Over the strenuous objection of [the U.S. Securities and Exchange Commission], Judge Failla has granted our motion for leave to pursue an interlocutory appeal and stayed the district court litigation,” Paul Grewal, the chief legal officer for Coinbase, said on social media. “We appreciate the Court’s careful consideration. On to the Second Circuit we go.”
Alan Rosenberg, a partner with Markowitz Ringel Trusty + Hartog in Miami whose specialty includes crypto litigation, said of particular interest in the ruling and the underlying litigation is the Court’s emphasis on analyzing a crypto asset’s “ecosystem” to contrast these assets with commodities and applying that analysis to the Howey test.
“As cleverly—and perhaps accurately—noted by Coinbase, however, there are other commodities that appear to have no inherent value outside the ecosystem in which they are issued or consumed,” said Rosenberg, who is not involved in the matter.
The SEC did not respond to a request for comment.
‘Expired Taylor Swift Concert Tickets’
The SEC sued Coinbase in June 2023, alleging that the company operated as an unregistered broker, exchange and clearing agency by facilitating trades in digital assets, which it argued were securities, court records show.
The SEC argued that tokens traded on Coinbase met the criteria for securities because they involved investors pooling funds into a “common enterprise.” In addition, the SEC argued the common enterprise had an expectation of profits driven by others’ efforts, which are the key prongs of the Howey test, the legal standard used by the U.S. Supreme Court to determine if a transaction qualifies as an investment contract and needs to be regulated as a security.
However, Coinbase argued that the tokens lacked the contractual obligations inherent in traditional securities and that its operations fell outside of the SEC’s jurisdiction. In doing so, Coinbase moved for judgment on the pleadings, which the Southern District of New York granted in part and denied in part in an opinion and order entered in March. As a result, Coinbase moved to certify the order for interlocutory appeal under 28 U.S.C. § 1292(b).
Now, the federal district court has certified the order for interlocutory appeal because it “presents a controlling question of law regarding the reach and application of Howey to crypto-assets, about which there is substantial ground for difference of opinion, and the resolution of which would advance the ultimate termination of the SEC’s enforcement action.”
In reaching that ruling, Failla held in her 34-page opinion and order that appellate guidance would shape this case and influence a growing number of pending disputes on the conflicting conclusions of whether investments in cryptocurrencies meet the Howey test. For instance, Failla pinpointed the SEC’s actions against Ripple Labs and Terraform Labs.
In Ripple, which is pending on appeal, the court determined that there were distinctions between tokens sold to institutional investors and those sold to retail buyers, which is a stance Coinbase has urged the federal district court to adopt. By contrast, Failla rejected Coinbase’s narrower interpretation of Howey, when she emphasized the “economic realities” of the transactions.
Failla held that the absence of formal contractual obligations does not exclude crypto assets from being classified as securities if its purchasers reasonably expected profits based on the efforts of others. However, Failla acknowledged that her interpretation represented one view in an unsettled legal landscape.
“The significance of a crypto-asset’s digital ecosystem to the Howey analysis, particularly as a point of contrast with collectibles or other commodities, is a difficult issue of first impression for the Second Circuit,” Failla wrote in the opinion and order. The judge noted that Coinbase argued that plenty of commodities, such as “expired Taylor Swift concert tickets,” have inherent value outside the “‘ecosystem’” in which they are issued or consumed.
Failla held: “There is indeed substantial ground to dispute how Howey is applied to crypto assets and the role of the surrounding digital ecosystem in that analysis.”
