Lately, the SEC has occupied itself with calling out companies in the crypto space since they may be considered to be dealing with securities and should then be registered with the SEC and operate under its rules and jurisdiction. Otherwise, they are at the risk of incurring in penalties.
What’s the SEC’s stance?
On November of 2018, CNBC conducted an interview with the SEC Chairman Jay Clayton, whereby he declared that lots of commonly handled ICOs qualify as securities, and stressed the point that if an ICO is public and not registered, it is most likely not compliant. Earlier that year, the SEC had issued a Statement on Potentially Unlawful Online Platforms for Trading Digital Assets, which included various considerations for crypto traders, and which was apparently not very much regarded by crypto traders, since Chairman Clayton noted that, as of November 2018, there were no ICOs registered with the SEC. Said statement is far from being the only communication the SEC has issued in this regard since it has also produced guides, notices, etc. inviting cryptos to review their status and confirm whether they need to be compliant before the SEC or not.
Real Life Cases
The SEC has indeed addressed and in several occasions warned or penalized cryptos, when these are determined to be non-compliant. Bitcoin has been recognized as not a security, although Chairman Clayton did declare trading with it concerns the SEC, but many ICOs are surely considered as securities. On July 2017, a report was issued whereby DAO* tokens were defined as securities, and the SEC stressed that they should comply with their regulations “regardless of whether those securities are purchased with virtual currencies or distributed with blockchain technology.”
On November 2018, Zachary Coburn, founder of Ether Delta, was fined with nearly $400,000 for operating an unregistered national securities exchange. The SEC also announced that CarrierEQ Inc. (Airfox)** and Paragon Coin Inc.*** carried ICOs without registering or applying for an exemption, and thus imposed penalties of $250,000 to each, to which both companies consented. In addition to that, they have to register and file periodic reports to the SEC. As a precedent, in December 2017 Munchee, Inc.**** had to stop its offering and return resources to investors before its ICO due to a cease-and-desist order.
More recently, on April of this year, the SEC issued a “no-action” letter for TurnKey Jet, Inc.***** whereby it settled that the tokens it uses are not securities. (Yes, not everything is bad)
* The DAO was a decentralized autonomous organization which used blockchain to offer and sell tokens to raise capital.
** Airfox raised digital assets for an app that allowed users to earn tokens in exchange for watching ads.
*** Paragon raised digital assets to implement blockchain in the cannabis industry.
**** Munchee was seeking capital to improve an app of restaurant reviews.
***** TurnKey Jet is a business aircraft solution startup that uses tokens which must be immediately usable for purchasing air charter services, used only in TKJ wallets, and fixed at 1 USD value, among other things.
I Deal With Crypto. How do I know if I should be compliant with the SEC?
The characteristics of each ICO must be studied separately to determine whether they are to be considered as securities or not. The nature of the digital asset, the rights it conveys, how it is offered and sold (for example, if it is offered and sold as an investment contract, it is a security), and other aspects are to be considered. All other cryptos which engage in the offering, selling, distributing, marketing, promoting, buying, trading, facilitating exchanges, holding or storing, offering financial services such as management or advice with regard to digital assets must analyze their individual standing before the SEC. In general terms though, if an ICO involves the offer and sale of tokens or trading of other digital assets that may be defined as securities, it will most likely have to be registered with the SEC and be compliant with its rules. Also, if money will be raised through an ICO, this may be done in a private placement, or otherwise be registered with the SEC.
In these cases, other measures such as programs to reduce fraud risk must be implemented. Some cryptos may be exempt of registration, but they should study carefully the rules which delimit this in order to avoid problems with the SEC, and regardless of the outcome of their research, file the exemption, in which case activities involving digital assets considered as securities will still concern the SEC. In case the crypto is not exempted, then it will have to comply with different rules depending on whether it offers and sales digital assets, is an investment vehicle, or trades digital assets either as an exchanger or as a broker-dealer.
Where can I find these rules?
So you feel like diving into the primary sources, eh? That’s great! If you decide that even after studying the rules yourself you still want a professional team to help interpret the law, review your specific company needs and design the next steps, reach out to us. Mati helps all kinds of FinTech companies, but we’re especially devoted to crypto. Ok, back to the sources...
The Securities Act of 1933 (“Securities Act”), the Securities Exchange Act of 1934 (“Exchange Act"), the Investment Company Act of 1940 ("Investment Company Act"), the Investment Advisers Act of 1940 ("Advisers Act") and the Regulation of Exchanges and Alternative Trading Systems (“Regulation ATS”) and the U.S. Code are the main regulations to be regarded by companies which deal with securities.
The SEC has also published various guides and statements intended to help cryptos understand their regulatory duties, particularly the Statement on Cryptocurrencies and Initial Coin Offerings issued on December 2017.
As for highlights, Section 3 of the Securities Act sets forth the securities that may be exempted from registration, and Sections 4A and 5 of said Act develop most duties that must be complied with. The Investment Company Act is to be regarded with regard to the registration and regulatory framework for pooled vehicles that invest in securities, and the Advisers Act with regards to antifraud provisions.
It is clear that the SEC has taken a stance when it comes to crypto. The next move for companies which involve crypto or want to make an ICO is to carefully review the SEC rules and file for registration (with all that it involves, such as the duty to disclose financial statements and compliance with other rules) or for an exemption. They should also make sure their activities comply with anti-money laundering and know-your-customer obligations. In any case, the best option is to seek professional advice and ultimately file a request for criterion confirmation from the SEC.
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