New ruling in SEC’s Coinbase insider trading lawsuit comes as a blow to the crypto industry as judge finds secondary token sales were securities

As the legal debate continues over whether sales of cryptocurrencies constitute securities, all eyes have been on a court case involving a Coinbase employee sharing insider information with his brother and a friend. While the main defendant, former Coinbase employee Ishan Wahi, and his brother have reached settlements with both the Department of Justice and the Securities and Exchange Commission, the friend—Sameer Ramani—remains at large.

On Friday, a federal judge in the Western District Court of Washington issued a ruling in the case against Ramani. The ruling, which agreed in part to the SEC's request for a default judgment, could have serious implications for both Ramani and the broader crypto industry.

In the decision, Judge Tana Lin ruled that the case fell under the SEC's jurisdiction because the crypto assets at issue were securities, even though they were traded on Coinbase, a secondary market. As courts grapple with the question of when crypto assets are securities, the decision is the strongest decision yet by a federal judge to support Chair Gary Gensler's argument that the vast majority of the industry's activity falls under its remit.

Howey and its discontents

Since the rise of cryptocurrencies like Bitcoin and Ether, regulators have wrestled with how to classify digital assets. Should they fall under the category of securities like bonds and stocks, or commodities like gold and wheat?

Currently, the only cryptocurrency with regulatory clarity is Bitcoin, which the Commodity Futures Trading Commission declared to be a commodity in 2015. Other assets have remained in a gray zone. As a result, when exchanges like Coinbase offer cryptocurrencies for trading, they have operated under legal risk, despite declaring their belief that certain crypto assets should not be classified as securities.

Starting with SEC Chair Jay Clayton, and continuing under Gensler, the SEC has pursued a campaign of enforcement actions against crypto firms, arguing the firms are issuing or selling unregistered securities. With high-profile cases against companies like Ripple, Coinbase, and Binance, the SEC has sought to expand its jurisdiction over the vast majority of crypto assets, taking advantage of a lack of legislative movement in Congress.

Federal judges in the various cases have so far taken different stances on the securities question, adding to the uncertainty. In July, Judge Analisa Torres in the Southern District of New York sent shockwaves through the industry when she issued a ruling on the long-awaited Ripple case, arguing that direct sales of its XRP token to institutional investors like hedge funds constituted unregistered securities, while secondary sales on platforms like exchanges did not.

Later that month, Judge Jed Rakoff, also of the Southern District of New York, disagreed with her logic. In a ruling denying a motion to dismiss by the defendants, a crypto firm called Terraform Labs, he wrote that he rejected the approach.

"The Court declines to draw a distinction between these coins based on their manner of sale, such that coins sold directly to institutional investors are considered securities and those sold through secondary market transactions to retail investors are not," he wrote.

In December, Rakoff ruled in favor of the SEC and agreed that four crypto tokens offered by Terraform Labs constituted unregistered securities.

The matter has grown more complicated in two high-profile lawsuits brought by the SEC against major crypto exchanges, Coinbase and Binance. Unlike Ripple and Terraform Labs, the question with the two exchanges hinges solely on the trading of tokens on their venues, rather than the issuance.

Under U.S. case law, the definition of a security is drawn from a Supreme Court precedent called the Howey test, which defined a security as the investment of money in a common enterprise with the expectation of profits derived from the efforts of others. Both companies have sought to dismiss the cases, with their lawyers arguing that under Howey, securities must include an actual investment contract, which does not exist when purchasing crypto assets on an exchange. A third exchange, Kraken, employed the same logic when seeking to dismiss its own lawsuit by the SEC. Judges have yet to rule on the motions by Coinbase and Binance, and a hearing for Kraken's motion is scheduled for June.

Insider trading

The SEC's Coinbase insider trading lawsuit is a more complicated case because none of the defendants are crypto firms, but instead, individuals accused of using insider information for personal gain.

In two cases brought by the SEC and Department of Justice, prosecutors argued that a Coinbase employee, Ishan Wahi, shared confidential information with his brother and friend, who were able to net more than $1.5 million in trades.

From the beginning, the SEC's lawsuit has drawn concern from the crypto industry. To establish jurisdiction for the case, the SEC argued that the defendants were trading unregistered securities on Coinbase—in this instance, little-known tokens such as AMP and DDX, and not major cryptocurrencies like Ether and Solana. Prominent crypto firms including Coinbase and Paradigm filed "friend of the court" briefs to challenge the SEC.

Wahi and his brother settled with both the SEC and the DOJ, avoiding the risk of a judge ruling in the SEC's favor on the question of the security status of the tokens. That wasn't the case with their friend, Ramani, who the SEC believes to be in India, leading the agency to seek a default judgment on the case.

On Friday, Lin ruled in favor of the SEC, agreeing that sales of the crypto assets constituted securities, even when sold on secondary markets. In her decision, she argued that the tokens were broadly promoted by issuers, therefore creating an expectation of increased value. Furthermore, the issuers facilitated trading on secondary trading markets like Coinbase.

"The Court’s analysis remains the same even to the extent Ramani traded tokens on the
secondary market," Lin wrote, arguing that the promotional statements apply equally to tokens bought by an investor, whether directly from an issuer or on a trading platform. "Each issuer continued to make such representation regarding the profitability of their tokens even as the tokens were traded on secondary markets."

As a result, Lin ruled that every crypto asset that Ramani purchased and traded constituted investment contracts. Unlike Rakoff's ruling in the Terraform case, Lin's decision is significant because it involves secondary transactions, rather than sales directly from an issuer. At the same time, because it was a default judgment, there was no defense presented by the opposite side, as with the SEC's lawsuits against the major crypto exchanges.

Notably, the lawsuit is in the Western District Court of Washington, which is in the same appeals circuit as the Kraken lawsuit, which is being litigated in the Northern District Court of California. If one of the cases is appealed to the circuit court, the ruling from the three-judge panel will likely apply to the other case, although it is improbable that the Ramani case would be appealed because it was a default judgment. Regardless, because multiple lawsuits are being heard in different circuits across the country, the question of whether crypto assets constitute securities is likely to make its way to the Supreme Court.

A spokesperson for the SEC, Ramani, and Ramani's lawyer did not immediately respond to a request for comment.

This story was originally featured on Fortune.com