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SEC V. Coinbase | An Update And Summary

If you follow financial and crypto news, there are good chances you’re aware of the ongoing dispute between the SEC and Coinbase. The years-long saga is not just a complex legal battle. In taking its fight into the related fields of public relations, lobbying, and politics, Coinbase seeks to eschew the tethers of securities regulation by playing multi-dimensional chess.

Introduction

On the litigation front, the conflict turned hot in June last year when the SEC brought civil charges against Coinbase through a complaint filed in the United States District Court for the Southern District of New York. The SEC charged Coinbase with its crypto asset trading platform as an unregistered national securities exchange, broker, and clearing agency.

The below text briefly provides an update on the status of Securities Exchange Commission vs. Coinbase, Inc. and Coinbase Global, Inc., and a summary of the parties’ core arguments.  The case has not progressed quickly, but pending developments are likely to soon grasp the attention of many observers within the financial, crypto, and legal communities.

Status Of The Case

Pursuant to an early motion for judgment on the pleadings filed by Coinbase, the District Court put the ordinary course of proceedings on pause. The Court set a briefing schedule to allow the parties and interested non-parties to file legal briefs supporting or opposing the motion. Briefing on the motion is now closed. Several non-parties have filed “amicus curiae” briefs.

The Court will hear arguments on the motion for judgment on January 17, 2024, beginning at 10. a.m. EST. Given the great public interest in the dispute, the Court has made available a public “listen-only” line. To observe the arguments in real time, members of the public can dial in to the hearing by calling (888) 363-4749 and entering access code 5123533 at 10 a.m. on the 17th.

If you plan on listening in on the whole thing, be prepared. Each side will have four hours of oral argument to make their case. You may wish to stash a trove of your favorite coffee or energy drink nearby.

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A Wave Of New Data Privacy Laws: Should You Update Your Privacy Policies And Practices?

Are your privacy policy and practices adequate? Given a new wave of state-level data privacy laws, companies that collect customer information should consider whether updates are required. This applies especially to companies that do business online or use wireless devices to harvest personal information.

Customer Information and Data Privacy Law Prior to New Wave

There is no uniform or single body of law in the United States governing data privacy protection in the context of information collected from customers.

[1] Instead, there is a patchwork of federal and state laws that may apply to a company’s data collection and retention efforts depending on the type of activities performed by the company.[2] Typically, these laws apply to specific industry sectors, such as healthcare providers and financial institutions, to protect specific populations, such as minors, or to specific types of information.[3] Policy experts have referred to these laws as being grounded in a framework based on ‘”harm-prevention.”

Where sectoral special privacy laws don’t apply, the only federal law of general application is the Federal Trade Commission Act, which allows the Federal Trade Commission to force companies to abide by their own online privacy policies and to challenge certain data practices as unfair or deceptive.[4] To date, unless a specific data protection law applies, a company’s data collection activities are largely unregulated.[5] Thus, the content of most privacy policies has been driven by an interest in obtaining customer consent to avoid litigation[6] and by market dynamics.

Growing Body of State Law Comprehensive Regulating Data Privacy
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Contracts And The Importance Of Background Law

Introduction

Most people are relatively familiar with the importance of contracts when doing business or transferring property interests. They often rely on a general understanding of freedom of contract and the enforceability of voluntary contractual commitments, to enter contracts without legal advice.

Mandatory Legal Norms & Contracts

Less people are aware of how significantly background law can impact contracts, whether cemented in judicially developed case law, legislatively created statutes, or rules and regulations adopted by administrative agencies. When legal norms are mandatory, they are not waivable by contract, and they can have significant consequences on intended contractual arrangements.

Potential Consequences

Failure to consider background law can have an array of consequences, including fines or penalties. It can result in the non-enforceability of a contractual provision. In certain situations, it can even result in the nullity of a contract. For reasons like these (and many others), it is nearly always a good idea to consult with a qualified attorney when creating important contracts. This is true when creating contractual templates to be used repeatedly by a business, and when contracts address a sensitive subject matter like real property rights, transactions in securities, or employment. It should almost go without saying (but people sometimes need reminding) that this is especially the case when the value underlying an agreement is substantial.

Examples

The below paragraphs offer a few specific examples of how background law can impact contractual relationships. As the reader will note, failure to contemplate them can lead to extremely adverse consequences.
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Employee Exits: Texas Non-Compete Agreements In Post-Employment Disputes

In a recent post, I addressed the applicable framework under Texas law when employees not subject to non-compete agreements leave a job to compete with a former employer. This article addresses Texas law on non-compete covenants and its impact on potential disputes when covered employees exit and work in competitive roles.

Employers and employees alike have legitimate interests in these circumstances. Employers have an interest in protecting their investment in competitive information and knowledge held by the employee. On the flipside, exiting employees have a legitimate interest in earning a livelihood—and sometimes their only viable alternative might require a competitive role.

Recent Regulatory Scrutiny of Non-Compete Agreements

Because non-compete agreements can be used abusively, negatively impacting employees and burdening the free market, legislators and regulators have widely acted to restrain freedom of contract in connection with their use. A prospective federal regulatory proposal may soon eliminate their use in employment relationships nationwide.[i] But for the time being, Texas employers and employees would do well to familiarize themselves with the framework described below.

How Can Non-Compete Agreements Restrain Competition from Employees?

The “teeth” that compel compliance with covenants not to compete are (1) damage awards and (2) injunctive relief. Additionally, requests for injunctive relief to enforce non-compete covenants benefit from a special rule: the proponent need only show a substantial breach of a covenant for entitlement to a permanent injunction. See Butler v. Arrow Mirror & Glass, Inc., 51 S.W.3d 787, 795 (Tex. App.–Houston [1st Dist.] 2001, no pet.) (holding that a showing of irreparable harm was not necessary to support the lower court’s issuance of a permanent injunction); but see Argo Grp. US, Inc. v. Levinson, 468 S.W.3d 698, 702 (Tex. App.—San Antonio 2015, no pet.) (holding that a plaintiff seeking a temporary injunction under Tex. Bus. Com. Code § 15.51 must show a probable, imminent, and irreparable injury in the interim before trial); Primary Health Physicians, P.A. v. Sarver, 390 S.W.3d 662, 664–65 (Tex. App.–Dallas 2012, no pet.) (same). This significantly relaxes the proof required to support a permanent injunction.[ii]

These enforcement mechanisms drastically alter the legal framework governing relationships between employees and their former employers. Unless they are restrained voluntarily by agreement, former employees have a common law right to compete. Consequently, unless a non-compete agreement applies, in typical cases courts will not issue an injunction to restrain competitive conduct by a former employee post-exit. For the same reason, damage awards are not available in these circumstances unless the competing former employee’s pre-exit conduct breached a fiduciary duty or misappropriated a trade secret.
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Employee Exits: Preparations To Compete Despite Fiduciary Duties

Introduction

The dissolution of an employment relationship can provoke conflict, uncertainty, and stress. The stress can be heightened when the departing employee is likely to compete with the former employer, using knowledge and skill learned during the employment. This article addresses the legal framework that applies when at-will employees who are not subject to contractual restrictions exit an employment relationship and compete with their former employer.

Legal Duties of Employees: Agents as Fiduciaries

Employees owe legal duties to their employers. Kinzbach Tool Co. v. Corbett-Wallace Corp., 160 S.W.2d 509 (Tex. 1942). These duties result from the principal-agent relationship and arise from the law of agency. Id. This relationship imbues on the employee a duty to act primarily for the benefit of the employer in matters related to the agency. Johnson v. Brewer Pritchard, P.C., 73 S.W.3d 193, 200 (Tex. 2000). Essentially, within the scope of an employee’s agency relationship, an employee owes fiduciary duties to an employer. Abetter Trucking Co. v. Arizpe, 113 S.W.3d 503, 509 (Tex.App.-Houston [1st Dist.] 2003, no pet.) (citing Johnson at 200 (Tex. 2000)).

However, these duties generally do not survive termination of the employment relationship. “An employee may use his general knowledge, skill, and experience acquired in the former employment to compete.” Arizpe, 113 S.W.3d at 512 (citing Johnston v. American Speedreading Acad., Inc., 526 S.W.2d 163, 166 (Tex.Civ.App.-Dallas 1975, no writ)); see also Sands v. Estate of Buys, 160 S.W.3d 684, 687 (Tex.App.-Fort Worth 2005, no pet.); Rugen v. Interactive Bus. Sys., Inc., 864 S.W.2d 548, 551 (Tex.App.-Dallas 1993, no writ); Am. Derringer Corp. v. Bond, 924 S.W.2d 773, 777 (Tex.App.-Waco 1996, no writ). Consequently, employees are entitled to compete with their former employers unless the employer and employee restrict the employee’s future conduct by way of a covenant not to compete. Texas courts have described this right to resign and compete against a former employer as a constitutional right. See Ledel v. Bill Hames Shows, Inc., 367 S.W.2d 182, 184 (Tex.Civ.App.-Fort Worth 1963, no writ).
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Accredited Investor Status In Federal Securities Law

The term “accredited investor” is frequently heard in the field of financial investing. But many investors lack an in-depth understanding of the implications of accredited investor status or how it is acquired, especially investors accustomed to purchasing only assets sold in offerings that are registered with the SEC.

What is an Accredited Investor?

From a practical perspective, an accredited investor is a person to whom companies can sell securities[i] (e.g., stocks or bonds) in an offering that is not registered with the Securities Exchange Commission (SEC). Regulations passed under the Securities Act of 1933 include several definitions specifying how different types of persons can qualify as accredited investors.[ii] By implication, relevant regulations identify all such accredited investors as persons from whom companies may raise capital without first making detailed public disclosures. Essentially, accredited investors are deemed to have sufficient financial sophistication to forego the requirement of certain regulatory disclosures prior to investment.

Why is Accredited Investor Status Important?

Most investment in U.S. companies is raised through the sale of securities to accredited investors in “unregistered” offerings, which term describes offerings of securities that are not registered with the SEC. Registration is a laborious process that requires detailed public disclosures of a company’s business information and plans.

Despite their frequent use, unregistered offerings are unlawful unless they comply with the detailed guidelines of a “registration exemption.” The negative consequences of unlawful securities offerings can be very significant.[iii] Exemptions from registration allow for the lawful sale of securities in “exempt offerings.” The application of a registration exemption is contingent on compliance with detailed regulations and guidelines.[iv] Qualifying for an exempt offering can be difficult but is generally much easier when securities are sold only to accredited investors in “private offerings.” In 2019, according to the SEC, capital raised in exempt offerings accounted for about 70% of all capital raised in the United States and the most frequently used exemptions were those applicable to private offerings.[v] Thus, the most used avenues to raise equity capital in the United States are probably the registration exemptions for private offerings.
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Changes To Corporate Capital In Equity Financing Transactions, Part II

How Are Fiduciary Duties Applicable to Decisions Authorizing Changes to Corporate Capital?

The first post in this series analyzed whether shareholders may seek remedies in the context of charter amendments to facilitate changes to corporate capital in equity financings. The conclusion was that if an amendment to a corporate charter is properly adopted (and doesn’t violate an independent contractual obligation), shareholders can obtain a remedy only if the corporate action can substantiate a claim for breach of fiduciary duty against enough directors or control persons.

In situations where corporations are needy for additional capital, existing and potential stockholders often seek to maximize their potential benefits upon providing investments. They may control the company or control board seats. Some of the actions they take can adversely affect other shareholders’ interests. For instance, they may create a senior class of stock with superior right and preferences. Consequently, it is worthwhile to consider when shareholders can claim a breach of fiduciary duty in connection with equity financings or recapitalizations. This part of the series addresses how fiduciary duties of corporate directors and control persons apply in these circumstances in Texas and Delaware.

Directorial Fiduciary Duties in General

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Changes To Corporate Capital In Equity Financing Transactions, Part I

If the rule isn’t that anything goes with enough votes, what is it?

Experienced entrepreneurs and investors alike understand that equity dilution is a fundamental aspect of investing in corporations. This is especially true when companies anticipate needing additional capital prior to their prospective profitability. But investors do not always trust management to act fairly and wisely when they sell additional stock or restructure shareholder rights.

This is the first part in a series of blogs focusing on modifications to corporate capital in equity financings. In this first part, I evaluate the law applicable to charter amendments in both Texas and Delaware. As many readers know, Delaware is the leading U.S. jurisdiction for domiciling corporations and has a highly developed body of corporate decisional law. Texas does not benefit from the same depth or breadth of case law. Accordingly, Texas courts—like those of other states—frequently look to Delaware precedent when making determinations in connection with Texas corporate law. Nevertheless, both statutory and judge-made law in Texas and Delaware are different in important aspects.

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A Crypto Quagmire: Civil And Criminal Charges Filed Against A Coinbase Manager For Insider Trading Of Securities

Recently the SEC filed suit for insider trading of securities against a high-level employee at the popular crypto exchange, Coinbase. The SEC filed its civil suit in Seattle on July 22, 2022, against and his co-conspirators. On the same day, the DOJ announced the unsealing of a federal indictment against the same defendants in the Southern District of New York.[i] The following discusses the allegations and draws conclusions regarding the implications for the crypto industry.

Both crypto exchanges and issuers of tokens, should take heed of this development. Beyond the intrigue and drama, the facts of the case are instructive regarding the legal quagmire faced by many crypto industry participants. The relevant coins appear to have been designed to avoid definition as a security. Apparently, Coinbase’s due diligence and analysis agreed that the relevant tokens are not securities.

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Crypto Currency Legislation Pending In The 50 States

Introduction

With the crypto industry’s dramatic loss of market capitalization in recent weeks, some of the shimmer and gravitational attraction has shaken off digital assets. Consequently, some of the impetus behind legislative efforts related to digital assets and technology may have been lost this year. But digital assets and the blockchain technology on which they reside are likely to continue to interest investors and consumers and to play an important, albeit sometimes disruptive, role in modern economies.

Therefore, state legislatures remain likely to pass several crypto-related bills that vary widely in their subject matter and scope, including proposals that clarify existing regulation, create new regulatory frameworks, and dedicate state resources to support or study the impact and use of digital assets. This month the National Conference of State Legislatures surveyed legislation pending in each of the U.S. states and territories. See Heather Morton (June 6, 2022), Cryptocurrency 2022 LegislationNCLS.ORG. This post synthesizes and summarizes the content of that publication, with a focus on identifying general trends in the subject matter of the pending bills.

Despite significant legislative interest in crypto, not all states have bills pending this year. The legislatures of Nevada, North Dakota, and Texas are at rest during this fiscal year, with no regular sessions scheduled. Others had no digital assets legislation introduced. At the time of the NCLS report, the following states and territories had not introduced digital assets legislation in 2022: Arkansas, Delaware, D.C., Puerto Rico, Guam, Maine, Maryland, Texas, Nevada, U.S. Virgin Islands, Wisconsin, and South Dakota.

New York, Hawaii, and Arizona are among the jurisdictions with the most bills pending related to crypto and digital assets. Filed bills in New York include one that would create a moratorium on cryptocurrency mining centers. Another would create new criminal offenses, including for token fraud, rug pulls, private key fraud, and fraudulent failure to disclose interests in virtual tokens. New York would also require certain disclosures in advertisements involving virtual tokens. California also has significant, substantive legislation pending.

Pending Legislative Proposals

Below is a list the subject matter addressed by the most common bills pending and the states in which they have been proposed. These proposals would:

(1) Allow or prohibit some or all political subdivisions or agencies to pay employees and others in virtual currency, to accept payment in virtual currency, or to use virtual currency as collateral in state financings.

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