U.S. District Judge Vince Chhabria of the Northern District of California. Photo: Jason Doiy/ALM

Coinbase will likely sidestep allegations of insider trading amid the December launch of its bitcoin cash trading feature, but U.S. District Judge Vince Chhabria said the cryptocurrency exchange company clearly botched the rollout.

Chhabria said investors' negligence claims get past the San Francisco-based company's motion to dismiss a second amended complaint, filed by Arizona resident Jeffrey Berk. The bitcoin cash investors allege the company recklessly deployed trading of the currency Dec. 19 and abruptly shut it down a mere two minutes after opening, saddling some users with charges hours later at a market price nearly $2,000 higher than when they placed the order.

“When it began supporting trading in bitcoin cash, it had an obligation to create a fair and orderly market for that commodity, and it did not satisfy that duty, and they owed that duty to anyone that would be trading on that platform,” Chhabria said during a hearing in the U.S. District Court for the Northern District of California.

However, Chhabria said he would be surprised if Lynda Grant of The Grant Law Firm in New York City could convince him that Coinbase committed fraud. The investors claim the company tipped of insiders to allow them to purchase bitcoin cash from other markets on the cheap, and then “pump and dump” on Coinbase's platform at an inflated price.

“I think in terms of their theory of nefariousness, they're really just floating trial balloons,” Chhabria said.

Rather than intentionally deceiving traders, Chhabria speculates that Coinbase rolled out the platform before it was ready while facing tightening competition that could've harmed its business.

Steven Ragland, a San Francisco-based Keker, Van Nest & Peters attorney defending Coinbase, said the company's duties to its customers is defined in its user agreement and trading rules. Chhabria interrupted to argue the company's responsibility goes above and beyond those contracts. Since Coinbase created a platform where a market for a commodity is established and presides over its exchange, it has an obligation to be careful with users' money regardless of its user agreement, he said.

“I think the special relationship Nasdaq or Coinbase has with people trading on platforms—there's a duty to ensure the trading isn't going to be a disaster,” Chhabria said.

To prove that Coinbase does not have a special relationship with investors, Ragland pointed to a class action lawsuit against Apple. U.S. District Judge Richard Seeborg dismissed negligence claims last May that Apple's Powerbeats 2 headphones were not water- and sweat-resistant, as advertised. Seeborg said the claim would only work if Apple had a special relationship with its customers, a relationship that is only established when a product is marketed to a specific customer and not to the general public.

“It seems like the relationship between a trading floor and investors is different from Apple and the general consuming public,” Chhabria said, adding Coinbase targeted a class of investors and established a relationship of trust that seems absent in the Apple case.

Ragland also tried to distinguish Coinbase's role in the bitcoin cash trading launch from Nasdaq's handling of Facebook's 2012 public offering. In 2015, Nasdaq bankrolled a $26.5 million settlement with the social media company over claims it bypassed state and federal laws by not revealing issues with its IPO technology. Unlike Nasdaq, Coinbase is not subject to securities claims, Ragland said. When asked what laws do govern bitcoin cash, a hard-fork variation of bitcoin software, he said the U.S. Securities and Exchange Commission has not given definitive guidance and that the legal jurisdiction is still in flux.

Arguing for mandatory arbitration, Erin Meyer of Keker Van Nest said that many investors' claims of harm are covered under its user agreements and trading rules. For instance, users cited “massive slippage” of the bitcoin cash unit price as evidence of Coinbase's negligence. Meyer says “significant slippage” is covered in the contracts users sign, which also bind traders to mandatory arbitration.

“This is a contract claim dressed up like a tort claim,” Meyer said.

Chhabria said the inflated prices were not just due to slippage. “The slippage concept is assuming a fair and orderly market, and you might not get the price you agreed to because of slippage,” he said. “This is setting up a market that is dysfunctional and will not allow for orderly trading.”