The ongoing legal battle between the Securities and Exchange Commission (SEC) and Coinbase has sparked heated debates among legal experts. The contention lies in the SEC’s interpretation of the term “investment contract” which, according to a group of law professors, is at odds with the historical understanding of the term.
Legal Scholars Challenge SEC’s Interpretation
On Friday, a team of six legal scholars, including professors from Yale Law School, Fordham Law School, and the University of Chicago Law, submitted an amicus brief supporting Coinbase. They contended that the SEC’s broad interpretation of an “investment contract” exceeds its historical boundaries.
These scholars, who clarified that they were not representing their respective institutions, aimed to lend their expertise to the case, potentially influencing the lawsuit’s outcome.
SEC’s Allegations Against Coinbase
The SEC filed a lawsuit against Coinbase in June, accusing the company of functioning as an unregistered broker, clearinghouse, and exchange. Central to these allegations is the SEC’s claim that at least 13 cryptocurrencies traded on Coinbase are unregistered securities.
The SEC has applied the Howey Test, a measure that determines whether a transaction qualifies as an “investment contract”, to these tokens. This test considers whether there is an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”
The Howey Test and its Impact on Crypto
The Howey Test has become a critical tool in the crypto space, most notably in the SEC’s case against Ripple labs over the sale of XRP. Despite the SEC’s intent to appeal, District Judge Annalisa Torres ruled that Ripple’s programmatic sales of XRP did not meet the Howey Test’s requirements.
However, the same reasoning was not applied to the SEC’s case against Terraform Labs and Do Kwon. The SEC argues that the existence of an “investment contract” can include a “scheme” and does not necessarily require a formal contract between parties. This view has been challenged by the group of legal scholars.
Historically, an “investment contract” required a contractual agreement between buyers and sellers, a principle established when the Securities and Exchange Act of 1934 was passed, the scholars pointed out. They based their argument on decisions related to blue-sky laws, which the 1934 Act was modeled after.
According to the scholars, by 1933, state courts had agreed that an “investment contract” referred to a contractual arrangement that entitled an investor to a contractual share of the seller’s later income, profits, or assets. They emphasized that every “investment contract” identified at the highest levels of America’s legal system involves a contractual undertaking between buyers and sellers.
The scholars argued that the SEC’s current interpretation would constitute a deviation from case law established both before and after the Securities and Exchange Act of 1934. They emphasized that an “investment contract” requires contractual undertakings to deliver future value reflecting the income, profits, or assets of a business.
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