Key Takeaways

• A New York federal court dismissed a class action suit by Coinbase customers who accused the cryptocurrency exchange of engaging in the sale of unregistered securities and failing to register as a broker-dealer, in violation of federal and state securities laws.
• Relying heavily on the terms of Coinbase’s user agreement, the court determined that Coinbase was not a “statutory seller” of the alleged securities and, therefore, not subject to the cited federal securities laws.
• The court granted Coinbase’s motion to dismiss without reaching the question of whether the tokens at issue were securities.

Case Background

On February 1, the U.S. District Court for the Southern District of New York dismissed a putative class action brought by customers of Coinbase Global Inc. and its subsidiary Coinbase Inc. (together, Coinbase), alleging the cryptocurrency exchange had sold unregistered securities in violation of state and federal laws.[1] Coinbase and its founder/CEO, Brian Armstrong, were named defendants.

Originally filed in October 2021, the suit alleged that Coinbase operated as an unregistered securities exchange or broker-dealer. A March 2022 amended complaint identified 79 tokens available on Coinbase that plaintiffs alleged qualified as “securities” subject to federal and state securities laws.[2] Because Coinbase users who sell tokens on the platform must first place the assets into a Coinbase-controlled centralized wallet, plaintiffs argued that buyers transacted with Coinbase—rather than with other users—when purchasing tokens. As such, Coinbase held title to the purported securities and would qualify as a “statutory seller” subject to the registration requirements of federal securities laws.

Plaintiffs alleged violations by Coinbase of: (1) sections 5 and 12(a)(1) of the Securities Act of 1933 (Securities Act), which imposes registration requirements for those who offer or sell securities; (2) Section 29(b) of the Securities Exchange Act of 1934 (Exchange Act) related to allegedly illegal contracts entered into with users to purchase and sell securities in violation of registration requirements; and (3) related state securities laws. Plaintiffs also brought “control-person” claims arising under Section 15 of the Securities Act against Coinbase Global Inc. and Armstrong for their alleged involvement with the other alleged federal law violations.

In May 2022, defendants moved to dismiss the amended complaint. They asserted that the 79 tokens were not securities, but that the court need not reach that fact-intensive question on a motion to dismiss. Rather, defendants largely based their motion on the argument that Coinbase was not a “statutory seller.”[3]

Decision Granting Coinbase’s Motion to Dismiss

The court recognized that, while the issue of whether the tokens were securities would be “central” if the case proceeded, that issue was “more suitably litigated at summary judgment.” For the sole purpose of deciding the motion to dismiss, the court simply accepted as true plaintiffs’ allegation on this point. However, the issue became irrelevant upon the court’s further determination that plaintiffs failed to plead that Coinbase was a statutory seller within the meaning of the Securities Act and that, on that basis, all claims should be dismissed.

To reach its determination, the court applied the test articulated in Pinter v. Dahl,[4] under which Coinbase would be a statutory seller if: (1) Coinbase passed title in the tokens as the “immediate seller” to the buyer for value, or (2) Coinbase solicited the purchase of the tokens motivated, at least in part, by a desire to serve its own financial interests or that of the tokens’ owners. The court held that plaintiffs failed to adequately plead the first scenario. First, the terms of the Coinbase user agreement “flatly contradict[ed]” plaintiffs’ allegations that Coinbase—not the users—held title to tokens traded on the platform. The user agreement provided that title to all digital assets on the platform remained with the user, not Coinbase, and users buying or selling digital assets on the platform were transacting with other users, not Coinbase directly. Second, the court noted that while the amended complaint characterized Coinbase as the title holder of the tokens and the only counterparty to the token purchases, plaintiffs’ original complaint alleged that users entered into trade agreements with other Coinbase users.[5] Therefore, the court rejected the amended complaint’s contrary allegations, which the court suggested were “strategically added to elude the facts pled in the [original] complaint and contained in the User Agreement,” and held that plaintiffs failed to plead that Coinbase was a statutory seller under Pinter.

The court further found that plaintiffs failed to plead the second Pinter scenario. Plaintiffs did not demonstrate that Coinbase directly and actively participated in the solicitation of the sale, and even if they had pled direct solicitation, plaintiffs did not plead that they purchased and sold the tokens as a result of Coinbase’s solicitation. Although plaintiffs had alleged that Coinbase engaged in solicitation by providing users with token descriptions and their purported value, writing and linking to articles about the tokens, and participating in promotions such as airdrops of free tokens, the court characterized these activities as part of “the marketing efforts, ‘materials,’ and ‘services’” offered by an exchange, insufficient to constitute active solicitation under Pinter. The court also reasoned that even if this activity constituted solicitation, plaintiffs did not adequately allege that they were induced to purchase tokens as a result.

The court also dismissed plaintiffs’ Exchange Act and control-person claims. The court rejected the former, stating that each Coinbase transaction involving the alleged securities constituted a separate illegal contract for the purchase or sale of unregistered securities that could be rescinded, and held that the only contract capable of rescission was the user agreement, performance of which did not necessitate illegal acts. The court dismissed the latter because liability was premised on the Securities Act and Exchange Act claims, which the court dismissed.

Ultimately, the court granted Coinbase’s motion to dismiss in its entirety. The court dismissed with prejudice the federal law claims determining that granting leave to replead would be futile as plaintiffs had already amended their complaint and did not identify any amendments that would cure their claims. Because the state law claims were dismissed as a result of the court’s decision not to exercise supplemental jurisdiction, they were dismissed without prejudice.

Conclusion

The Coinbase decision underscores the importance of carefully drafting and understanding cryptocurrency exchange user agreements and terms of service. The decision may also provide some comfort to U.S. centralized exchanges that they may not be recognized as a “statutory seller” of securities subject to certain federal securities laws. However, the decision has far less impact on the ongoing debate of whether many tokens offered on such exchanges qualify as securities under federal securities laws. Because the court here did not address this point, market watchers and industry participants will need to look elsewhere for guidance, including to the district court’s upcoming decision in the SEC’s case against Ripple, where this question is squarely before the court.

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