Coinbase Ex-Manager Convicted of Insider Trading Is Crypto’s Latest Legal Hope

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WASHINGTON—Crypto has picked an unlikely ally in its battle against oversight by Wall Street’s chief regulator: a former Coinbase Global Inc. employee convicted of insider trading.

Ishan Wahi, a former manager at Coinbase, pleaded guilty this year to giving his brother and a college friend trading tips that generated almost $1.5 million in illicit profits. An Indian immigrant, he could serve more than three years in prison and be deported after doing time. 

But Mr. Wahi is still fighting the Securities and Exchange Commission, which sued him because it says some of the Coinbase assets were securities. The outcome of that civil case isn’t likely to change Mr. Wahi’s future, dimmed by his prosecution and likely imprisonment. But it could affect how digital assets are regulated in the U.S.

In a motion seeking early dismissal of the case in Seattle federal court, Mr. Wahi’s lawyers argue the SEC doesn’t have a role because Coinbase’s digital assets aren’t securities. Prosecutors charged him with conspiracy to commit wire fraud, not securities fraud.

Opposing the SEC in lawsuits like the one against Mr. Wahi has become the crypto industry’s best hope for beating back the commission’s campaign to regulate digital assets. The industry hopes federal judges will find that crypto is too different from traditional stocks and bonds to fall under rules written for Wall Street. 

Because Coinbase is also a target of an SEC enforcement probe, Mr. Wahi’s prospects are aligned with the company’s, even though it fired him and cooperated with the investigations of his role in the insider trading.  

The SEC’s staff last week told Coinbase it is likely to recommend enforcement action against the company over listing assets that regulators believe are securities, among other suspected violations, according to the company. If the SEC does sue Coinbase, the outcome could force the company to stop trading some of the digital assets it offers to its users and potentially alter the growth of the industry.

Regulators’ civil case against Mr. Wahi, already under way, is likely to play out before any broader suit against Coinbase is resolved, and its outcome could set a precedent for what assets the SEC can oversee.

“This goes beyond the impact of the prior enforcement cases where the entire case came down to that early point in the life of a token, when the company exchanges it for money,” said Nick Morgan, a Los Angeles attorney whose nonprofit organization, Investor Choice Advocates Network, represents people fighting what it calls SEC overreach. “The Wahi case has a much larger impact because this by definition involves secondary and not initial transactions.”

Coinbase faces the prospect of an SEC lawsuit.PHOTO:MICHAEL NAGLE/BLOOMBERG NEWS

Mr. Morgan’s ICAN group is one of several organizations that filed friend-of-the-court briefs supporting Mr. Wahi’s arguments. The Digital Chamber of Commerce and the Blockchain Association, two crypto trade groups, also filed briefs that attacked the SEC’s case. Coinbase has asked the judge to allow the company to submit its views.  

An SEC spokesman declined to comment. A Coinbase spokeswoman declined to comment but pointed to recent statements on Twitter by Paul Grewal, the company’s chief legal officer. The SEC could have created “practical, lasting solutions like developing rules or registration options” for the industry, Mr. Grewal wrote, but instead filed a “misguided suit.”

The Jones Day law firm is representing Mr. Wahi against the SEC and filed a motion to dismiss the case in February. Coinbase isn’t paying for Mr. Wahi’s lawyers, according to two people familiar with the matter. A Jones Day spokesman didn’t respond to repeated messages asking who is funding its work.

In their motion, Jones Day lawyers say the SEC’s efforts to police crypto violate the major-questions doctrine recently adopted by the Supreme Court. The standard restricts regulators from writing rules or taking other steps that have vast economic or political significance without what the majority of justices consider explicit direction from Congress.

Jones Day also attacks the SEC’s reliance on a 76-year-old Supreme Court test known as Howey to regulate many crypto projects. The Howey case provided a definition for an “investment contract,” a type of security that can be regulated by the SEC. 

“The SEC may not use the phrase ‘investment contract’ as a blank check to cash whenever it seeks to expand its regulatory ambit,” Jones Day and other lawyers for Mr. Wahi wrote in the brief. 

At his plea hearing on the wire-fraud charges in February, Mr. Wahi admitted to tipping his brother and college friend Sameer Ramani but said he “relied on the statements of Coinbase and others that these cryptocurrencies are not securities.” He apologized and said he would lose “the entire life that I’ve worked hard to build over the last 17 years,” according to court transcripts. 

Mr. Wahi is scheduled to be sentenced in May. His brother, who pleaded guilty to the criminal charges, was sentenced in January to 10 months in prison and ordered to forfeit $892,500 in trading gains. 

Supporters of the SEC’s enforcement campaign for crypto say a court shouldn’t view Mr. Wahi as a sympathetic defendant. “It’s just the latest instance of the crypto industry’s scorched-earth litigation tactics against any attempt by the SEC to enforce the law,” said Dennis Kelleher, chief executive of Better Markets, a group that pushes for tighter financial regulation. 

Defendants who plead guilty to criminal insider-trading charges typically don’t contest the SEC’s related civil allegations. “The facts admitted in the criminal case are pretty unattractive,” said Mr. Morgan, who previously worked as an SEC enforcement attorney.

Coinbase is also seeking to intervene in Mr. Wahi’s case with a friend-of-the-court brief. The company faces the prospect of an SEC lawsuit alleging it violated laws that require registration as a licensed securities brokerage and exchange, according to a copy of the SEC’s enforcement warning, known as a Wells notice. 

“The SEC’s allegations in this case hinge on the agency’s erroneous contention that Coinbase has listed digital assets that are securities,” the company’s lawyers wrote in a filing submitted last week.