On November 16, 2018, the Securities and Exchange Commission's (SEC) Divisions of Corporation Finance, Investment Management, and Trading and Markets issued a statement on digital asset securities issuance and trading, highlighting several recent SEC enforcement actions involving digital asset securities.

The enforcement actions outlined in the statement covered the following three categories of activity:

Across these areas of activity in the blockchain/cryptocurrency space, the Divisions emphasized that they are taking a functional, facts-and-circumstances approach to applying the existing federal securities law framework to new technological innovations.

Enforcement actions in this category, such as the settled orders issued against AirFox and Paragon, have mainly focused on the following questions:

Specifically, AirFox and Paragon agreed to pay penalties and to register the tokens they sold as securities under Section 12(g) of the Exchange Act. As a result, they will be required to file periodic reports with the SEC, and to compensate investors who purchased tokens in the illegal offerings if an investor elects to make a claim. As noted in the statement, these provide a roadmap to compliance with the federal securities laws for other token issuers, even where issuers have already conducted an illegal unregistered offering of digital asset securities.

On September 11, 2018, the SEC issued the Crypto Asset Management Order, finding that the manager of a hedge fund formed for the purpose of investing in digital assets had improperly failed to register the fund as an investment company. The statement cautions 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 and the Investment Advisers Act.

Exchange registration. On November 8, 2018, the SEC issued an order instituting cease-and-desist proceedings in its first-ever enforcement action against a digital asset trading platform. The platform, EtherDelta, is an online platform for secondary market trading of ERC20 tokens, a type of blockchain-based token commonly issued in ICOs. The order found that EtherDelta was operating as an unregistered national securities exchange.

The statement notes that 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.

Broker-dealer registration. On September 11, 2018, the SEC issued an order against TokenLot, a self-described "ICO superstore" where investors could purchase digital assets, including digital asset securities, during or after an ICO, including in private sales and pre-sales. As mentioned in the statement, an entity that facilitates the issuance of digital assets securities in ICOs and secondary trading in digital asset securities may also be acting as a "broker" or "dealer" that is required to register with the SEC and typically become a member of the Financial Industry Regulatory Authority (FINRA).

The statement mentions that the TokenLot order illustrates the application of the broker-dealer registration requirements to entities trading or facilitating transactions in digital assets securities, even if they do not meet the definition of an exchange.

For more information on recent cryptocurrency enforcement actions, see Legal Updates: