At first blush it does not appear that the program, which allows customers to lend their currency is a security, but we have not seen the SEC's files, so anything is possible.
Coinbase has released a statement regarding the Wells Notice, explaining its position, here. Coinbase claims that the SEC is relying on SEC vs. Howey and Reves, but that it will not explain why or how those cases apply to their lending program.
The lending program is not yet live, and there is very little public information on the program, but it sure does not look like a security. According to Coinbase, its proposed program allows its customers to lend (not borrow) its USD Coin (USDC) known as a stablecoin to others, for 4% interest.
SEC vs. Howey
Howey is the seminal Supreme Court case defining what is a security. In simple terms, according to Howey, a security is an investment of money in a common enterprise, with the expectation of making a profit from the efforts of others. In an oversimplification, stocks, bonds, and promissory notes with a term of more than nine months, are all securities, and subject to SEC regulation.
Reves vs. Ernst & Young
Since there are types of notes which, under a traditional Howey analysis, may not be deemed "investment contracts" but still bear a resemblance to a security, the Supreme Court in Reves v. Ernst & Young, set forth the “family resemblance” test to determine whether a note is a security. Reves sets forth an analysis that starts with the assumption that a note is a security unless the note bears a resemblance to one of the categories on a list of exceptions. If the “note” does not bear a resemblance to an item on the list, the analysis continues to determine if a new category should be added to the list.
The rationale underlying Reves is important in the Coinbase situation. In Reves, the court stated
First, we examine the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into it. If the seller's purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a "security." If the note is exchanged to facilitate the purchase and sale of a minor asset or consumer good, to correct for the seller's cash-flow difficulties, or to advance some other commercial or consumer purpose, on the other hand, the note is less sensibly described as a "security." Second, we examine the "plan of distribution" of the instrument to determine whether it is an instrument in which there is "common trading for speculation or investment." Third, we examine the reasonable expectations of the investing public: The Court will consider instruments to be "securities" on the basis of such public expectations, even where an economic analysis of the circumstances of the particular transaction might suggest that the instruments are not "securities" as used in that transaction. . . . Finally, we examine whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Acts unnecessary.
Is The Coinbase Lend Program a Security?
While the details of the program have not been released, it seems that Coinbase's lend program is not a security under Howey or Reves. Using the Reves analysis, the loan, or note, is not being used to finance a substantial investment. Rather, the loan, or note, is provided to advance a consumer purposed, i.e. to enhance the return on the lender's separate investment.
Where Coinbase may get tripped up is in the plan of distribution, with Coinbase facilitating the distribution of these notes. However, the third factor is the reasonable expectations of the investing public, which can only be to earn interest on an existing investment, the stablecoin.
Coinbase says that it is holding off on releasing the program, as it does not understand the SEC's issue with the program. More disturbing is Coinbase's claim that the SEC will not explain its position, or offer any guidance.
Regulation by Litigation
Regulation by litigation is never a proper regulatory endeavor. Let's find out what the SEC's issue is, and let Coinbase launch its program in a compliant manner.
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The attorneys at Sallah Astarita & Cox, LLC have over 100 years of combined experience representing all participants in the securities markets, including the cryptocurrency markets. For a consultation, or to simply ask a question, give them a call at 212-509-6544
