On July 21, 2022, the US Department of Justice (DOJ) unsealed an indictment charging Ishan Wahi (Wahi), a former product manager at a large cryptocurrency trading platform (the Platform)—along with his brother Nikhil Wahi (Nikhil) and friend Sameer Ramani (Ramani)—with wire fraud and conspiracy to commit wire fraud for an alleged insider trading scheme using Wahi’s position to funnel confidential information to the others regarding digital assets set to be listed on the Platform before their public announcement.[i] On the same day, the Securities and Exchange Commission (SEC) filed a first-of-its-kind civil action against the trio alleging they violated federal securities laws because the SEC alleges that certain of the digital assets are securities.[ii] The DOJ’s action appears to signal an emerging trend of “insider trading” prosecutions in the digital asset space, and the potential effects of the SEC’s civil claims could have dramatic implications for actors in the digital asset space, especially trading platforms.
According to the indictment, Wahi began working at the Platform as a product manager in October 2020. In this role, Wahi was involved in the process of listing new digital assets on the Platform, and had access to highly confidential information, including (1) which assets would be listed on the Platform, and (2) the timing of public announcements for the listings. In particular, during the period of the alleged criminal activity, Wahi was a member of a small, private chat group used to discuss the precise dates and timeline for announcements and launch dates. Wahi allegedly tipped off either Nikhil or Ramani before major announcements, to capitalize on the value bump digital assets often receive following listing announcements by the Platform. Nikhil and Ramani used various exchange accounts held in others’ names to purchase the digital assets, and then transferred the funds to anonymous Ethereum wallets. The trio allegedly obtained at least $1.1 million in illicit profits from the scheme.
In addition to the DOJ’s indictment, the three men face civil claims filed by the SEC, which alleges they violated Section 10(b) and Rule 10b-5 of the Securities Exchange Act by engaging in their scheme. The complaint marks the first time the SEC has brought an insider trading action related to digital assets. While the DOJ refrained from filing securities fraud charges, instead charging the defendants with wire fraud and conspiracy to commit wire fraud, the SEC’s complaint alleges that at least nine of the assets involved are securities under the Howey test, including assets that are considered utility tokens or offered by decentralized autonomous organizations.[iii] It alleges, among other things, that the assets were securities because they were sold to investors to raise funds for the issuer’s businesses while the issuers asserted their efforts would increase the tokens’ value, and that the assets could be resold on secondary markets.
The SEC’s complaint comes at a time when regulatory jurisdiction over digital assets is at a critical juncture. On June 7, US Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) proposed bipartisan legislation to overhaul the framework for digital assets regulation, including classifying most digital assets as commodities and empowering the Commodities Futures Trading Commission (CFTC)—rather than the SEC—to regulate most of the industry.[iv] A ruling that these assets are securities could further cloud the very issues the legislation seeks to clarify and greatly expand the SEC’s jurisdiction over the digital asset industry. In a rare public statement about another agency’s litigation, Caroline D. Pham, a CFTC Commissioner, characterized the action as “regulation by enforcement,” echoing concerns about the SEC’s regulation of digital assets previously expressed by others, including SEC Commissioner Hester Peirce.[v] The Platform’s Chief Legal Officer, in turn, has stated in a blog post that the Platform agrees with Commissioner Pham, reiterating that none of the assets at issue are securities and that it disagrees with the SEC’s decision to file these securities fraud charges. CFTC Commissioner Pham also said that considering the implications of this case—namely, determining whether the nine digital assets are securities—it is important for regulators to work together in a transparent process that engages the public. “Regulatory clarity comes from being out in the open, not in the dark.”
The DOJ indictment and SEC action evidence an increased focus by regulators and enforcement agencies on illicit activity involving cryptocurrencies and digital assets. Notably, the indictment is not the DOJ’s first attempt to prosecute “insider trading” involving digital assets. On May 31, 2022, the DOJ charged Nathaniel Chastain with wire fraud and money laundering related to the alleged insider trading of non-fungible tokens (NFTs) on a large, online NFT marketplace.[vi] This recent indictment suggests that the DOJ will seek to rely on wire fraud and other non-securities fraud charges to prosecute digital asset-related schemes that resemble insider trading schemes, at least in cases where securities are not involved. Indeed, in announcing the indictment, US Attorney Damian Williams was clear: “Web3 is not a law free zone,” and the DOJ will be “relentless” in pursuing fraud—irrespective of whether it occurs on the blockchain.[vii]
The SEC action, moreover, throws fire on the already tense debate regarding whether certain digital assets are securities or commodities, and which regulator has primary jurisdiction over them. The SEC’s complaint asserts its jurisdiction over these digital assets—in line with SEC Chair Gary Gensler’s repeated refrain that all tokens are securities—despite the Lummis-Gillibrand proposed legislation putting these types of assets generally under CFTC purview.[viii] Chair Gensler seems to anticipate the issue, stating that the SEC is “not concerned with labels, but rather the economic realities of an offering.”[ix]
Further, the SEC’s complaint is a direct shot at the crypto industry and raises a couple of significant questions. First, Chair Gensler has long suggested that digital asset trading platforms should voluntarily register as an exchange under federal securities laws.[x] Such trading platforms have generally resisted given the compliance costs and impracticability. But if any of the digital assets on a trading platform is a security—and the SEC alleges that nine are—that platform must register as an exchange under federal securities laws or seek an exemption, such as the exemption provided for alternative trading systems (ATSs) under Regulation ATS. The SEC may be moving toward a more hard line approach regarding the registration or exemption of digital asset trading platforms, which could result in an existential crisis for those companies because exchanges can only list registered securities—very few digital assets are registered—and exempt ATSs must still comply with a host of regulatory requirements that may be challenging for these platforms.
Second, the SEC alleges that nine digital assets at issue in the trio’s scheme are securities—but closer examination of these allegations raises more questions than answers regarding the SEC’s stance on what constitutes a security.[xi] For example, the SEC alleges that the following are probative of whether a digital asset is a security:
- statements by the assets’ developers promoting their experience and leadership;
- developers listing their digital assets on trading platforms; and
- asset holders receiving profits derived from staking the digital asset.
It is not clear how any of these factors support a finding that a digital asset is a security. Statements about product developers’ experience are commonplace across many different industries. The fact that the developers want to list their assets should not mean that those assets are any more securities than bitcoin—which is also listed on nearly every crypto trading platform and which the SEC has acknowledged is not a security. Finally, as staking typically requires an affirmative action by the asset holder, and the profits from staking would not be solely derived from the efforts of others, it is not apparent how staking is relevant to the analysis.
If the SEC considers those factors as relevant to determining whether a digital asset is a security, many more digital assets would likely be considered securities. Given that the SEC has not alleged that the remaining 16 digital assets are securities, can the industry conclude that those digital assets are not securities in the eyes of the SEC? Unlikely—in light of the SEC’s allegations about the nine digital assets, it seems the SEC might later allege those, too, are securities.
Whether the SEC’s complaint is a one-off action or a sign of things to come, the SEC appears to have turned up the heat on an industry already inundated with uncertainty.
[ii] Securities and Exchange Commission v. Wahi et al., Docket No. 2:22-cv-01009 (W.D. Wash. Jul 21, 2022).
[iii] SEC v. Howey, 328 U.S. 293 (1946).
[xi] Whether a digital asset is a security subject to federal securities regulation is determined using the four-part test established by the US Supreme Court in SEC v. Howey Co., 328 U.S. 293 (1946). Under the Howey test, a digital asset would be a security if it involves (1) an investment of money (2) in a common enterprise (3) with a reasonable expectation of profits (4) derived from the efforts of others.