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DEF and Beba Sue the SEC; Legal Actions Against KuCoin; Update in SEC v. Coinbase; New EU AML Regulation does not Ban Self-Custody

DEF and Beba Sue the SEC

What happened?

Last Monday, DEF and Beba, an apparel company, sued the SEC. Beba airdropped $BEBA tokens as part of its marketing efforts and now seeks a court order declaring that: (1) its free airdrop was not a securities transaction and (2) $BEBA tokens are not investment contracts. In addition, DEF and Beba argue that the SEC’s behind-closed-doors adoption of its policy that nearly all digital assets and digital asset transactions are securities breached the agency’s notice-and-comment rulemaking obligations under the Administrative Procedures Act. 

What does this mean?

The lawsuit was filed in the federal District Court for the Western District of Texas. The SEC has 60 days from the filing to respond to the brief. DEF will provide updates as the matter develops. 

For more information, please see DEF’s blog post.

Legal Actions Against KuCoin

What happened? 

Last Tuesday, the U.S. Department of Justice (DOJ) and the Department of Homeland Security unsealed an indictment against global centralized cryptocurrency exchange KuCoin and two of its founders, Chun Gan and Ke Tang. The indictment brings criminal charges against KuCoin for allegedly conspiring to violate the Bank Secrecy Act (BSA) by failing to implement required anti-money laundering (AML) and customer verification (KYC) programs, and for operating a money transmitting business without registering with the Financial Crimes Enforcement Network (FinCEN). 

On the same day, the Commodity Futures Trading Commission (CFTC) initiated its own legal proceedings against KuCoin and its founders in a civil enforcement complaint, alleging that the exchange failed to comply with the Commodity Exchange Act (CEA) and related regulations. According to the CFTC’s compliant, “KuCoin solicited and accepted orders, accepted property to margin, and operated a facility for the trading of futures, swaps, and leveraged, margined, or financed retail transactions involving digital assets that are commodities including bitcoin (BTC), ether (ETH), and litecoin (LTC)” without properly registering with the Commission.

Last December, KuCoin also reached a $22 million settlement with the New York Attorney General in which it agreed to block New Yorkers from its platform as a result of charges that it “fail[ed] to register as a securities and commodities broker-dealer and [] falsely represent[ed] itself as a crypto exchange.”

What does this mean? 

In their lawsuit, the CFTC again classified ether (ETH) as a commodity, contradicting the SEC’s campaign to classify nearly all cryptocurrencies other than bitcoin as securities. These warring assertions from two federal agencies underscores and aggravates the uncertainty U.S. businesses must navigate when engaging in crypto-related activities.

Concerning the charges brought upon by the DOJ, centralized exchanges have long been considered money transmitters under the BSA for some time, and they are therefore required to comply with the BSA’s AML requirements and to register as a money services businesses. Essentially, none of these issues are new. From the DeFi perspective, these legal actions have limited implications.

Coinbase’s Motion for Judgement on the Pleadings Was Partially Denied 

What happened? 

Last Wednesday, in SEC v. Coinbase, Judge Katherine Failla of the Southern District of New York issued an order denying in part and granting in part Coinbase’s motion for judgment on the pleadings. The court dismissed the SEC’s allegation that Coinbase acted as an unregistered broker through its Wallet application, but the remaining claims continue to further proceedings. 

Coinbase’s motion for judgment on the pleadings asked the court to decide whether the SEC’s allegations “plausibly support” the SEC’s claims that 1) crypto asset transactions on Coinbase’s platform constitute investment contracts; 2) Coinbase, through its staking program, engaged in the unregistered offer and sale of securities; and 3) Coinbase acted as an unregistered broker through its Wallet application. 

In the order, Judge Failla held that the SEC plausibly alleged that at least some crypto asset transactions on Coinbase’s platform constitute investment contracts. Specifically, in discussing the Howey test, the court found that a formal contract or contractual obligation is not required for an investment contract to exist.

Additionally, the court considered the SEC’s theory that an asset’s “ecosystem” — the “contracts, expectations, and understandings” surrounding the crypto asset — is relevant in evaluating whether an investment contract exists. The court found that in the context of secondary market transactions, the SEC’s allegations, taken as true at this stage, plausibly support the claim that crypto asset transactions on Coinbase’s exchange satisfy the Howey test and thus are investment contracts. 

Regarding staking, the court held that the SEC plausibly alleged the “Staking Program constitutes an investment contract under Howey, given, among other things: (i) the risk of loss associated with participation in the Staking Program, (ii) Coinbase’s significant technical efforts in implementing and maintaining the Program, and (iii) Coinbase’s promotional efforts to drive customer participation in the Program.”

On the other hand, the court dismissed the SEC’s claim that Coinbase acted as an unregistered broker through its Wallet application. In the order, the court held that Wallet does not carry out “routing activities in a manner recognized by courts to have been traditionally carried out by brokers.” In defining “broker,” courts have considered a list of factors, including whether a person or entity provides trading instructions to third parties, directs how trades should be executed, or participates in the order-taking or order-routing process, etc. The court held that Coinbase’s Wallet application merely provides “technical infrastructure” for users to arrange transactions on their behalf and Coinbase has “no control over a user’s crypto-assets or transactions” through Wallet. Thus, the court found that the SEC’s allegations lacked any plausible claim showing that Coinbase acted as a broker through Wallet. 

What does this mean?

First, Coinbase’s motion for judgment on the pleadings was an aggressive strategic choice so early on in a litigation and it was a long shot that the whole case would be dismissed. It is actually a huge win for DeFi that the court granted the motion with respect to Wallet. Second, because the case is still pre-discovery, a partial denial simply means that the case will proceed to discovery, summary judgment, or potentially a trial. These later stages allow the judge to examine and decide the case with a developed factual record and further briefing.

For more of our thoughts on what this order means, check out our blog post on the topic.

No, the New EU AML Regulation does not Ban Self-Custody

What happened?

On March 19th, the European Parliament approved new anti-money laundering regulation (AMLR). This new AMLR places restrictions on anonymous cash payments for covered entities within the European Union. Although the internet was quick to sensationalize the application and scope of this new AMLR, the new regulation only focuses on centralized exchanges. 

The regulation contains explicit cut-outs for hardware, software, and other providers of self-custody wallets. Updates to reporting obligations and new restrictions apply specifically to crypto-assets service providers (CASPs), which are centralized entities regulated under the EU’s MiCA framework. The AMLR focuses on entities with custody over assets, which excludes by definition self-custody wallets and other decentralized finance entities, not included in the MiCA framework. However, the AMLR does require CASPs to implement enhanced due diligence processes for transactions involving self-custody wallets, as well as monitor transactions between their platforms and self-custody wallets. 

What does this mean?

Contrary to what some reports were saying, the AMLR does not place a ban on self-custody. Instead, it imposes requirements on CASPs that are meant to mitigate any risk of money-laundering and terrorist financing. However, as Austin Campbell explained on X, these regulatory requirements could lead CASPs to implement their own restrictions or controls on transactions with self-custody wallets as a measure to manage their own compliance risk. Therefore, the downstream effects of the AMLR remain to be seen. 


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