BeInCrypto - The Securities and Exchange Commission (SEC) has freely made use of the Wells Notice. But Coinbase’s vigorous response to a recent notice has prompted some investors to criticize the exchange for its actions in Ripple’s legal entanglements. Coinbase (NASDAQ:COIN) did not give Ripple the benefit of the doubt, they say, and now it vocally defends itself against similar charges. Whatever one’s view of this matter, the question stands. Should companies and exchanges let people know they are in the SEC’s crosshairs?
A Wells Notice can have dramatic reputational, legal, and financial repercussions for its target. For instance, Ripple suffered when Coinbase delisted XRP in January 2021 following Ripple’s receipt of a notice.
Fast forward to the present, and exchanges’ actions in regards to Wells Notices have drawn a range of speculations and concerns within the crypto community.
What a Wells Notice Means
A Wells Notice is a warning from the SEC that it intends to bring an enforcement action against a person or entity. It allows the recipient to respond to the SEC’s allegations before the enforcement action. The notice takes its name from John Wells, the SEC’s enforcement chief from 1972 to 1981.
Exchanges, as intermediaries in securities transactions, can receive Wells Notices in certain situations. For example, if an exchange is accused of facilitating manipulative trading or failing to enforce its own rules, the SEC may issue a Wells Notice. When the exchange receives it, a prompt response to the SEC is probably wise.
Clearly, a Wells Notice can have dramatic consequences for a firm’s reputation. But there is legal precedent holding that companies are not required to disclose the receipt of a Wells Notice.
Consider a 2012 ruling involving Goldman Sachs (NYSE:GS). The SEC had sent the company a Wells Notice related to an investigation into its mortgage-related securities. Goldman decided not to disclose the Wells Notice to its investors. Even the SEC did not pursue charges against the company.
Later, a shareholder lawsuit filed alleging that Goldman had failed to disclose the Wells Notice. Still, the court ultimately ruled in favor of the company. Finding that it had no legal obligation to inform others about the notice.
Repercussions of a Wells Notice
In theory, firms want to be transparent. But a Wells Notice can be a death knell for a company that has never been formally charged. Even one that is innocent of violating securities laws.
Receiving a Wells Notice can harm a company’s reputation, even when not charged with wrongdoing. The mere whisper of a pending SEC investigation can create negative publicity and FUD. It can affect a company’s stock price and investor confidence. In some cases, the mere receipt of a Wells Notice can be enough to lead to a loss of business. Or other negative consequences.
For example, the fintech firm Ripple faced repercussions when Coinbase delisted XRP in January 2021 following Ripple’s receipt of a notice. The delisting of XRP from Coinbase resulted directly from the Wells Notice Ripple received from the SEC in December 2020.
The notice alleged that XRP was a security and that Ripple had conducted an unregistered securities offering in violation of federal securities laws. This led to bad publicity for Ripple and XRP. Several other cryptocurrency exchanges and trading platforms followed Coinbase’s lead and delisted XRP.
The delisting had serious consequences for Ripple, as it reduced the liquidity and market value of XRP and made it more difficult for token holders to buy and sell it. In addition, the delisting raised questions about the legality and regulatory status of XRP and Ripple, which could have a long-term impact on the company’s and its token’s future.
However, delisting XRP does not necessarily mean that Ripple is guilty of the charges in the Wells Notice. The SEC has not decided whether XRP is a security or Ripple conducted an unregistered securities offering. Ripple has vigorously denied the allegations and has vowed to fight the SEC in court, and the case is ongoing.
Coinbase Faces Censures From XRP Holders
Ripple and its supporters have continued to argue that XRP is not a security. They say Ripple did not conduct an illegal securities offering. They have also criticized Coinbase and other exchanges for delisting XRP without a final determination from the SEC.
Their argument still holds in 2023, with Coinbase in receipt of a notice from the American regulators. Coinbase has hit back hard. The exchange published a post saying that it had asked the SEC to publish clarifications about rules, only to be served with a legal notice. Triggered in relation “to an undefined portion of our listed digital assets,” Coinbase Earn, Coinbase Prime, and Coinbase Wallet.
In their response, Coinbase executives called for an open dialogue rather than litigation.
Coinbase CEO Brian Armstrong concluded that the company would defend itself and “stand up for the rule of law for everyone.” So, why did Coinbase move so swiftly against Ripple in 2021? Traders of Ripple’s token XRP are irritated at Coinbase for not re-listing the security. Given Coinbase’s heated response to the SEC over its Wells Notice.
Coinbase officials maintain that they complied with securities laws. This is precisely the point of contention in the XRP vs. SEC lawsuit. It was only because of the lawsuit that Coinbase said it was suspending the XRP trading pairs on its platform. Hence, when the exchange argues it did not list securities, some in turn insist that Coinbase should reinstate XRP.
Backing Coinbase
Some experts vocally support Coinbase in its feud with the SEC. According to lawyer and digital assets enthusiast Bill Morgan, the Coinbase cryptocurrency exchange relied on the views of some senior staff of the SEC to justify its delisting of XRP as Ether and Bitcoin continue to trade on its platform.
Morgan has referenced the importance of Bitcoin and Ether trading on Coinbase as the reason the exchange would continue to defend its position. According to the lawyer, Coinbase’s draft registration statement showed that 65% of the trading on its platform in the six months up to June 2020 was Ethereum and Bitcoin.
Morgan believes that even if there was a proceeding in which the SEC named Bitcoin and Ethereum as securities, Coinbase would cease trading both digital assets only if wrecked financially. Hence, XRP was easier to sacrifice in the heat of the moment.
Focusing on SEC’s Action
While a Wells Notice is not a formal charge, it is severe. It means the SEC is at least considering an enforcement action. The purpose of a Wells Notice is to provide the recipient with an opportunity to respond beforehand. And, to present its case before the SEC takes any formal action. This is consistent with due process and the principles of fairness.
Plus, the SEC’s enforcement actions are subject to judicial review. And individuals or companies have the right to challenge the actions in court. Therefore, the SEC’s use of Wells Notices is not an extrajudicial process. Individuals or companies subject to enforcement action are not deprived of due process.
But the question of whether a company should disclose a Wells Notice is complex. Ultimately, whether to disclose a Wells Notice requires careful consideration of various factors. Including legal requirements, the potential impact on the company’s reputation and business operations, and the potential benefits of proactive disclosure. Companies should work closely with legal counsel and other advisors to assess the risks and benefits of exposure.
Here are some general guidelines on how exchanges should respond to Wells Notices:
Review the allegations carefully: The first step an exchange should take upon receiving a Wells Notice is to review the allegations. The exchange should understand what the SEC is accusing it of. What evidence has the SEC to support its claims? This will help the exchange determine the appropriate response.
Seek legal counsel: Exchanges should seek the advice of experienced securities lawyers as soon as possible after receiving a Wells Notice. Legal counsel can help the exchange assess the strength of the SEC’s case and develop a strategy for responding to the charges.
Other Steps
Conduct an internal investigation: If the allegations in the Wells Notice involve conduct by the exchange or its employees, the exchange should conduct an internal investigation. And determine whether the charges have merit. The results can help formulate a response to the SEC.
Respond to the SEC: The exchange should respond to the Wells notice within the time frame specified in the notice. The response should address each of the SEC’s allegations and provide any evidence or arguments that support the exchange’s position. The answer should be thorough, well-reasoned, and supported by documentary evidence where possible.
Consider settlement: If the exchange believes the SEC’s allegations have merit, it may consider settling with the SEC rather than litigating the case. Settlement can be less expensive and less time-consuming than litigation, and it can also help the exchange avoid negative publicity.
Be prepared for litigation: If the exchange decides to contest the SEC’s allegations, be ready for a long and costly legal battle. The exchange should have a plan for responding to discovery requests, filing motions, and preparing for trial.
Communicate with stakeholders: Finally, the exchange should let its stakeholders. Including investors, members, and regulators, know about the Wells notice and its response. The exchange should be transparent about the allegations and its efforts to address them.
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