Understanding Landmark Crypto Decisions: Underwood v. Coinbase
I. Introduction
This landmark case is titled: Christopher Underwood et al., Individually and on Behalf of All Others Similarly Situated, (Plaintiffs) v. Coinbase Global, Inc., Coinbase, Inc., and Brian Armstrong (Defendants), hereby referred to as Underwood v. Coinbase. The crux of the altercation arises from the plaintiffs’ alleged loss of funds following their use of Coinbase’s trading platform.
The plaintiffs brought three sets of claims:
“Under Section 12(a)(1) of the Securities Act of 1933 (the “Securities Act”), for damages arising from Coinbase’s sale or solicitation of unregistered securities, AC ¶¶ 931-41.
Under Section 29(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), arising from illegal contracts Coinbase entered into with its users to purchase and sell securities in violation of the Exchange Act’s registration requirements, id. ¶¶ 956-88”.
Under state law, based on Coinbase’s sale of unregistered securities and failure to register as a broker-dealer, id ¶¶ 1016-1106" (Underwood v. Coinbase, 2023).
II. Plaintiffs’ Claims
The plaintiffs initiated this lawsuit after incurring losses in their trades on Coinbase. They argue that by operating as a centralized exchange, Coinbase falls under federal securities laws, providing the plaintiffs with a legal avenue to seek recovery for their losses. The claim also argues that the tokens transacted on Coinbase hold the characteristics of a “security” and should be treated as such legally.
More specifically, the plaintiffs argue that transactions on Coinbase occur where Party A sells a Token to Coinbase, Coinbase assumes title of the Token, and then Coinbase sells the Token to Party B. Coinbase, however, argues that they are simply facilitating the transaction between Party A and Party B with their platform and technology.
III. Securites Act Ruling
Under the Securities Act, the court finds that the plaintiffs have legal standing only if one of two scenarios occur. The first scenario is if “Defendants were the direct sellers of the Tokens to plaintiffs” (Underwood v. Coinbase, 2023). The court, citing two key reasons, refutes the assertion and consequently rules in favor of the defendant.
The first, and most important, reason is that Coinbase never actually held title to the Tokens. This fact is painfully clear from an intellectually honest reading of Coinbase’s user agreement. The agreement states that “title to Digital currency shall at all times remain with you and shall not transfer to Coinbase” (User Agreement § 2.6.1). Thus, because title never transferred to Coinbase, they were never direct sellers of the Tokens.
The second reason is that the plaintiff's original complaint (this ruling is about their amended complaint) had legal and factual claims that are diametrically opposed to the ones put forward in the amended complaint. There is precedent for this exact matter, which states that you cannot file one complaint — which fails to get a desired result — and then completely rework the pattern of facts to file a new complaint.
The second scenario that would have needed to occur for the Court to rule in the Plaintiffs favor is if “Defendants actively solicited the sale of Tokens to plaintiffs and did so for financial gain” (Underwood v. Coinbase, 2023). The plaintiffs refer to Coinbase’s marketing efforts to gain a broader, more active consumer base as “solicitation” to buy tokens. Nevertheless, Coinbase’s advertising and marketing campaigns failed to align with the court's definition of solicitation, leading to another ruling against the plaintiffs.
IV. Exchange Act Ruling
Under the Exchange Act there are two claims relating to Coinbase’s alleged use of illegal contracts. The first claim falls under Section 29(b). Here, the plaintiffs argued that each purchase/sale of a token constitutes its own individual contract. They further argue that each contract is based on the illegal purchase/sale of an unregistered security provided by an unregistered broker. Thus, the plaintiffs contended that the contract should be rescinded.
The Court ruled against the plaintiffs on this claim as they were unable to successfully demonstrate that “the contract involved a prohibited transaction” (EMA Fin., LLC v. Vystar Corp., Inc., No. 19 Civ. 1545 (ALC) (GWG), 2021 WL 1177801, at *2 (S.D.N.Y. Mar. 29, 2021). Additionally, although the plaintiffs avoided mentioning the Coinbase user agreement in the amended complaint, they did explicitly reference it in their original complaint. The user agreement is undeniably a lawful contract, rendering any argument for rescission untenable.
Second, the plaintiffs brought allegations relating to “Control Person Liability” under Section 20 of the Exchange Act. A “Control Persons” argument is a claim against specific entities or individuals in securities matters, which alleges those individuals have considerable influence over a company and should thus be held liable for that company’s actions. In this case, the plaintiffs use this claim to implicate Coinbase Global and Brian Armstrong (the CEO). These claims, however, also fail as they are based on the substantive Exchange Act claims, which the court already denied.
V. State Law Ruling
The plaintiffs also brought state claims which, in substance, were very similar to their federal claims. Legal precedent states that federal jurisdiction applies to state law claims “that are so related to claims in the action within such original jurisdiction that they form part of the same case or controversy under Article III of the United States Constitution.” 28 U.S.C. § 1367(a). Ultimately, the court declined to exercise jurisdiction over these state-level claims and dismissed them without prejudice.
VI. Conclusion
This lawsuit serves as an exceptional clarifier for where the legal system stands on the regulation of the crypto industry. Fundamentally, this demonstrates that crypto exchanges can handle billions of dollars without being bound by the federal securities laws that regulate traditional financial institutions.