On March 7, 2018, the Securities and Exchange Commission’s Enforcement Division and its Trading & Markets Division issued a joint “Statement on Potentially Unlawful Online Platforms for Trading Digital Assets.”[1]  The release appeared to be the strongest signal yet of a broadening of the SEC’s enforcement and regulatory interest beyond its focus over the last year on the need for certain coin offerings to be registered or to qualify for an exemption as private placements.

The SEC staff’s release provided a laundry list of potential regulatory pitfalls for digital asset trading platforms and urged market participants to exercise caution and get advice from legal counsel in analyzing applicable requirements.  It also offered consultations directly with SEC staff, as needed, as a way to assure the correctness of positions being taken.

The threshold issue remains, of course, whether the assets traded are within the definition of “securities” under the longstanding “facts and circumstances” test of the Howey case.[2]  However as a resource, the release directed readers to recent statements by SEC Chairman Jay Clayton that suggest a disposition to generally find coin assets to be securities (“to date ICOs have largely been” securities offerings).[3]

If the assets are securities and the platform operates as an exchange, as defined by statute,[4] then the release spells out a series of issues to consider.  The platform may have to register as an exchange or seek to operate under the exemption for alternative trading systems under Reg ATS.  As an exchange and self-regulatory organization (SRO), the platform would have to adopt appropriate rules, policies, and procedures to prevent fraud, enforce compliance, and discipline members.  As an ATS, the platform would have to file Form ATS with the SEC, register as a broker-dealer, become an SRO member and thus subject to SRO oversight, and have policies and procedures to protect material non-public information, books and records requirements, and financial responsibility rules.

Additionally, by offering digital wallet services or transacting in digital securities, a trading platform may come under other registration requirements, including those for broker-dealers, transfer agents, or clearing agencies.  And by offering such securities, the platform may be participating in an unregistered offer and sale of securities.  In presenting this array of possible issues, the staff has effectively provided a roadmap of what the Enforcement Division will be looking at near term.

Finally, the staff used their release to caution investors that if they use a trading platform not registered with the SEC, they may lose the protections that would otherwise be available under the securities laws.  The staff offered a list of questions for investors to ask, including questions about how the platform selects assets for trading, who can trade, trading protocols, how prices are set, fees, protection of users’ information, protection against cyber threats, and safeguarding of users’ assets.

The key takeaway from the March 7 release is that the scope of the SEC staff’s interest in digital assets is widening.  With this in mind, now is the time for trading platforms to take a hard look at actual and planned operations and to ask questions to anticipate and avoid problems.  It appears from the release that the SEC Enforcement staff will be active on a number of new digital fronts soon.

ENDNOTES

[1] Available here: https://www.sec.gov/news/public-statement/enforcement-tm-statement-potentially-unlawful-online-platforms-trading.

[2] SEC v. W.J. Howey Co., 328 U.S. 293 (1946)

[3] Testimony of SEC Chairman Jay Clayton before U.S. Senate Committee on Banking, Housing and Urban Affairs, Feb. 6, 2018, available here: https://www.sec.gov/news/testimony/testimony-virtual-currencies-oversight-role-us-securities-and-exchange-commission.

[4] An “exchange” is an entity or group that “constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities,” or that is “otherwise performing” what are “generally understood” as securities exchange functions.  Securities Exchange Act §3(a)(1), 15 U.S.C. §78c(a)(1).

Stephen J. Crimmins is a partner in the New York law firm of Murphy & McGonigle, a securities boutique established in 2010.