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Further Thoughts on Coinbase: Two Mysteries

posted by Adam Levitin

I've been puzzling over two mysteries in the Coinbase saga:  first, why does Coinbase care so much if Lend is deemed a security, and second, why did the SEC want the list of Coinbase customers who had signed up in advance for Lend. I don't know that I've got all of this sussed out, but I figure I'll put my thinking out into the Internets and see if others have thoughts.

Why Does Coinbase Care?

Why does Coinbase care if Lend is a security?  Coinbase has already done a registered offering of its equity securities, so what's the big deal about having to do another registered offering of a debt security product?  Registering Lend doesn't move Coinbase into a new regulatory category, although if Lend is a security, then the securities fraud statute (including anti-manipulation and insider trading) applies to it, and there is the possibility of SEC enforcement. None of that seems like such a big deal, however. 

Instead, I think the problem is that the registration regime might be fundamentally incompatible with continuous issuance of a fixed-rate debt instrument like Lend.  Coinbase isn't planning on doing a one-shot sale of Lend. Instead, it plans for Lend to be a continuously offered product. That means that it needs to have an up-to-date registration statement continuously in effect for Lend.

Now a continuous shelf registration using a base prospectus would be possible under Rule 415(a)(ix), but the problem is that every time Coinbase would want to adjust the APY offered—a material term of Lend—it would have to file a new prospectus supplement.  A prospectus supplement has to be filed at least two days before it is first used, so that would leave Coinbase exposed to offering an above market APY for two days every time it wanted to lower the yield.  What would be likely to happen in those two days is that a huge amount of money woudl flood into Lend to take advantage of the above-market APY, potentially sticking Coinbase with a loss on the product. I suppose Coinbase could try to work around this by pricing Lend at a premium for those two-day windows, but that's a mess.  Maybe someone deeper into securities offerings knows of a workaround here, but this looks like a problem as far as I can tell.

Put another way, it might well be that Lend isn't a product that works if it has to be registered. And given that Coinbase is relying on Lend to be one of its growth areas, that's a problem.  

Why Did the SEC Want the Customer List?

Coinbase was very upset that the SEC wanted the list of customers who signed up in advance for Lend.  The question that puzzled lots of folks is why the SEC would want this list. Was it part of some sort of AML/tax crackdown?  Asking for names seems ominous. 

Actually, I think it's far more innocent, but shows that Coinbase might already be in more trouble than I first thought (and would explain the Wells Notice better).  I don't think the SEC actually cares about the particular names on the list. Instead, it wanted the list because it is evidence that Coinbase has already engaged in an unregistered offering of securities. There's no magic moment that signifies the commencement of an offering, but signing up customers in advance is pretty good evidence of an offering already taking place, even if the actual product isn't yet available.  That would then explain the Wells Notice.  It seemed strange for Coinbase to get a preemptive Wells Notice--if Coinbase hadn't actually engaged in an unregistered offer yet, the SEC would be unlikely to send a Wells Notice, because a Wells Notice is a notice about what charges the SEC staff intends to recommend. I am not sure if it is used when the SEC seeks preemptive relief (itself a rarity).  It makes a lot more sense for the SEC to send a Wells Notice alerting Coinbase that it is planning on recommending charges about an existing, rather than a possible future, unregistered offering. 

If I'm right here, then Coinbase cannot solve its problem by not proceeding with the Lend product. It's already too late, as Coinbase has already engaged in an unregistered offer. In that case, Coinbase's options are pretty limited—litigate or agree to a consent order.  I suspect that Coinbase will litigate, as it has nothing to lose from litigation.  If it is victorious, it gets to proceed with Lend, while if it loses, it will face minimal damages, but create a precedent that the SEC can use to go after Coinbase's competitors, resulting in the level playing field Coinbase wants. There's really no downside to Coinbase from litigating.

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