The US Securities and Exchange Commission (SEC) has obtained default judgment against Sameer Ramani in connection with its investigation and prosecution of the first US insider trading case relating to dealings in cryptocurrencies. The scheme in question occurred over 2021 and 2022 when Ishan Wahi, a former product manager at Coinbase, tipped his brother Nikhil Wahi and friend Sameer Ramani regarding the ‘timing and content of upcoming listings’ on the exchange. The confidential information obtained during the course of Wahi's employment was used to trade in cryptocurrencies yielding substantial profits for the defendants.
In the recent judgment, the Court ruled that the trading of certain crypto assets via a secondary market such as Coinbase constituted securities transactions. In particular, it focused on whether the tokens traded were investment contracts under US law. The Court, in the absence of any defendant, was required to adopt the SEC's submissions and stepped through the ‘three-prong’ Howey test:
(1) an investment of money (2) in a common enterprise (3) with an expectation of profits produced by the efforts of others
Investment of money
The Court had no difficulty in concluding that Ramani had made an investment of money in personally paying for the tokens that he acquired.
Common enterprise
The requirement of a common enterprise was held to be satisfied, with the Court affirming:
facts alleged are sufficient to show both horizontal and vertical commonality in the token trading enterprise.
Horizontal commonality refers to an enterprise common to a group of investors. This was held to be established as ‘every token-holder’s financial fortunes were intertwined with the continued success of the entire token trading enterprise.’
While it is not necessary to establish both, the Court nevertheless found that vertical commonality was also present, which involves an enterprise common to the investor and seller, promoter or some other third party. In making this finding, the court relied on factual allegations that the token holders and issuers shared a risk of loss.
Expectation of profits produced by efforts of others
This involved an objective inquiry into whether purchasers were led to expect financial returns by efforts other than their own. It was alleged that 9 token issuers identified in Ramani’s trades 'broadly and repeatedly disseminated claims that each token would appreciate in value’ as part of their promotion, promising to ‘create, develop, and maintain an ecosystem’ that would foster demand and price increase.
The Court also acknowledged that these promotional statements applied equally to indirect investors, who purchased their tokens via secondary markets. It cited the finding in SEC v Terraform Labs that public representations to persuade both direct and indirect purchasers ‘would presumably have reached’ those who purchase their tokens via secondary markets.
While acknowledging that the assessment of whether instruments purchased over a secondary resale market involved an investment contract requires consideration of the ‘economic reality of each transaction’ and ‘what investment package was actually offered’, the Court did not consider each transaction and token in isolation.
The Court finally concluded:
Thus, under Howey, all of the crypto assets that Ramani purchased and traded were investment contracts.
The Court’s analysis remains the same even to the extent Ramani traded tokens on the secondary market.
There are concerns that the Court's blanket finding may have bearing on the SEC’s separate enforcement action against Coinbase, which alleges that Coinbase facilitated unregistered securities transactions. However, as the judgment is only a default, without any litigation over the SEC's claims, the Court was required to adopt all of the SEC's submissions. Neither Coinbase nor the token issuers were a party to the present action and none of the allegations brought by the SEC in relation to the tokens in which Ramani traded were properly tested, and this decision will have no weight as a precedent in any other cases.
The outcome of the Coinbase case is hotly anticipated, following the hearing in January, where Justice Failla reserved judgment on summary judgment motions brought by the SEC and Coinbase.
Ramani now faces a civil penalty of over USD$1.6M and disgorgement of the identified proceeds UDS$817,602.
Separately, the SEC's civil claims against the Wahi brothers were settled in May 2023, with the brothers pleading guilty to wire fraud conspiracy in a separate criminal proceedings brought by the Department of Justice, with Ishan facing a sentence of 24 months in prison and Nikhil 10 months.
In dealing with this novel case, the SEC warned:
While the technologies at issue in this case may be new, the conduct is not…the federal securities laws do not exempt crypto asset securities from the prohibition against insider trading, nor does the SEC.
These proceedings highlight the need for cryptocurrency exchanges and businesses, in particular, to implement a token dealing policy to mitigate the risks of employees and contractors dealing in tokens based on inside information, manage potential conflicts and avoid reputational harm. While the SEC's allegations of insider dealing on the basis that the relevant crypto-assets were said to be securities were not properly tested in this case and as noted above, the decision has no precedent value, fraud offences and a range of other laws may also be invoked where an employee uses inside information for the purpose of seeking a profit.
Written by Kelly Kim and Steven Pettigrove and Michael Bacina