The Securities and Exchange Commission (SEC) continues to assert its regulatory authority over the cryptocurrency market. The agency recently issued an advisory regarding coin and token exchanges, suggesting that enforcement actions may be forthcoming.
SEC Oversight Over Cryptocurrency
As initial coin offerings (ICOs) become an increasingly popular way for businesses to raise capital, the SEC has made it very clear that it intends to consider all ICOs as security offerings. As we have discussed in greater detail in prior posts, ICOs rely on the same blockchain technology as Bitcoin. In ICOs, investors receive digital coins or tokens, which may be used to access the services offered by the business or resold to others in a secondary market on virtual currency exchanges or other platforms.
In a report issued this summer, the SEC clarified that an offer and sale of blockchain tokens pursuant to an initial coin offering (ICO) may be subject to U.S. securities laws. “Whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction,” the SEC advised.
In reaching this conclusion, the SEC applied existing federal securities laws. The agency also made it clear that issuers of distributed ledger or blockchain technology-based securities must register offers and sales of such securities unless a valid exemption applies. If they fail to register, entities participating in unregistered offerings also may be liable for violations of the securities laws. Additionally, securities exchanges providing for trading in these securities must register unless they are exempt.
In recent months, the SEC has continued its warnings to investors and industry participants. In January, SEC Chairmen Jay Clayton and CFTC Chairman Christopher Giancarlo published a commentary piece in the Wall Street Journal, entitled “Regulators Are Looking at Cryptocurrency.” They wrote:
The SEC is devoting a significant portion of its resources to the ICO market. Through statements, reports and enforcement actions the SEC has made it clear that federal securities laws apply regardless of whether the offered security—a purposefully broad and flexible term—is labeled a “coin” or “utility token” rather than a stock, bond or investment contract. Market participants, including lawyers, trading venues and financial services firms, should be aware that we are disturbed by many examples of form being elevated over substance, with form-based arguments depriving investors of mandatory protections.
The SEC has also backed up its position with enforcement actions. Last fall, the agency also created a new Cyber Unit, which is tasked with leveraging the Enforcement Division's cyber-related expertise on misconduct involving distributed ledger technology and ICOs, among other areas.
SEC Advisory on Coin and Token Exchanges
The SEC’s latest cryptocurrency advisory highlights that online trading platforms have become a popular way for investors to buy and sell digital assets, from ICOs. Many of these platforms bring buyers and sellers together in one place and offer investors access to automated systems that display priced orders, execute trades, and provide transaction data.
The SEC also notes that many platforms provide a mechanism for trading assets that meet the definition of a "security" under the federal securities laws. “If a platform offers trading of digital assets that are securities and operates as an ‘exchange,’ as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration,” the agency advisory states.
The SEC also warns investors that many online trading platforms refer to themselves as “exchanges” and may appear to investors as SEC-registered and regulated marketplaces when they are not.” Its advisory states:
Although some of these platforms claim to use strict standards to pick only high-quality digital assets to trade, the SEC does not review these standards or the digital assets that the platforms select, and the so-called standards should not be equated to the listing standards of national securities exchanges. Likewise, the SEC does not review the trading protocols used by these platforms, which determine how orders interact and execute, and access to a platform's trading services may not be the same for all users.
With this in mind, the SEC offers the following tips for investors:
- Do you trade securities on this platform? If so, is the platform registered as a national securities exchange?
- Does the platform operate as an Alternative Trading System (ATS)? If so, is the ATS registered as a broker-dealer and has it filed a Form ATS with the SEC?
- Is there information in FINRA's BrokerCheck ® about any individuals or firms operating the platform?
- How does the platform select digital assets for trading?
- Who can trade on the platform?
- What are the trading protocols?
- How are prices set on the platform?
- Are platform users treated equally?
- What are the platform's fees?
- How does the platform safeguard users' trading and personally identifying information?
- What are the platform's protections against cybersecurity threats, such as hacking or intrusions?
- What other services does the platform provide? Is the platform registered with the SEC for these services?
- Does the platform hold users' assets? If so, how are these assets safeguarded?
For businesses and investors considering an ICO, the SEC’s latest advisory offers further evidence that such offerings must comply with U.S. securities registration requirements. For detailed guidance, it is always advisable to consult with an experienced attorney.
If you have any questions about the SEC's advisory, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work at 201-806-3364.