On November 16, 2018, the SEC’s Division of Corporation Finance, Division of Investment Management, and Division of Trading and Markets (the “Divisions”) issued a statement on “Digital Asset Securities Issuance and Trading.” The statement highlights several recent SEC enforcement actions involving the intersection of the U.S. securities laws and new technologies.
The Divisions emphasized that market participants must still adhere to the well-established and well-functioning federal securities law framework when dealing with technological innovations, regardless of whether the securities are issued in certificated form or using new technologies, such as blockchain.
Specifically, the Divisions discussed the following three categories relating to issuing and trading digital assets:
- initial offers and sales of digital asset securities (including those issued in initial coin offerings (“ICOs”));
- investment vehicles investing in digital asset securities and those who advise others about investing in these securities; and
- secondary market trading of digital asset securities.
Offers and Sales of Digital Asset Securities
In connection with the offer and sale of digital asset securities, the Divisions pointed out that the SEC has brought a number of enforcement actions involving offerings of digital asset securities. To date, these actions have principally focused on two important questions:
- When is a digital asset a “security” for purposes of the federal securities laws?
- If a digital asset is a security, what SEC registration requirements apply?
The SEC has settled enforcement actions with several entities requiring the entities to pay a fine, to offer rescission rights to the investors and to file periodic reports with the SEC.
Investment Vehicles Investing in Digital Asset Securities
The Divisions also reminded the public that investment vehicles that hold digital asset securities and those who advise others about investing in digital asset securities, including managers of investment vehicles, must be mindful of registration, regulatory and fiduciary obligations under the Investment Company Act of 1940 and the Investment Advisers Act of 1940.
Trading of Digital Asset Securities
Secondary market trading of digital asset securities generally requires registration as a national securities exchange or registration as a broker or dealer, as those terms are defined under the federal securities laws unless there is an exemption.
a. Exchange Registration
A platform that offers trading in digital asset securities and operates as an “exchange” (as defined by the federal securities laws) must register with the SEC as a national securities exchange or be exempt from registration.
Any entity that provides a marketplace for bringing together buyers and sellers of securities, regardless of the applied technology, must determine whether its activities meet the definition of an exchange under the federal securities laws. Exchange Act Rule 3b-16 provides a functional test to assess whether an entity meets the definition of an exchange under Section 3(a)(1) of the Exchange Act. An entity that meets the definition of an exchange must register with the SEC as a national securities exchange or be exempt from registration, such as by operating as an alternative trading system in compliance with Regulation ATS.
Entities using blockchain or distributed ledger technology for trading digital assets should carefully review their activities on an ongoing basis to determine whether the digital assets they are trading are securities and whether their activities or services cause them to satisfy the definition of an exchange. An entity engaging in these types of activities should also consider other aspects of the federal securities laws (and other relevant legal and regulatory issues) beyond exchange registration requirements.
b. Broker-Dealer Registration
An entity that facilitates the issuance and secondary trading of digital asset securities may also be acting as a “broker” or “dealer” that is required to register with the SEC and become a member of a self-regulatory organization such as FINRA. SEC-registered broker-dealers are subject to legal and regulatory requirements that govern their conduct in the marketplace and that provide important safeguards for investors. Absent an exception or exemption, it is unlawful for any broker or dealer to induce or attempt to induce the purchase or sale, of any security unless such broker or dealer is registered with the SEC.
Any company looking to potentially offer digital assets through an ICO or any other method such as a “securities token offering” should contact legal counsel to ensure compliance with the U.S. securities law framework.
