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10 April 2018
On March 7 2018 the Securities Exchange Commission (SEC) issued a statement warning investors of potential risks involving digital asset exchanges.(1) The statement aims to protect investors trading digital assets through online platforms and serves as a warning shot to exchanges dealing in digital assets that may be securities.
The first section of the statement outlines factors that investors should consider when trading digital tokens on online platforms. The SEC warns investors that many platforms that refer to themselves as 'exchanges' may appear to be registered with and regulated by the SEC when in fact they are not; this means that they are not held to the same regulatory standards as national securities exchanges. The SEC also questions the adequacy of these platforms' trading protocols and data collection methods and cautions investors to perform due diligence and ask questions before trading any digital assets through them.
The second section of the statement focuses on operators of online trading platforms. The SEC again said that any platform operating as an 'exchange' and dealing in 'securities', as defined by federal securities laws,(2) must register with the SEC or have an exemption. The statement also cautions that even if an entity wishes to seek exemption from national securities exchange registration by operating as an alternative trading system, the entity must still register with the SEC as a broker-dealer and join a self-regulatory organisation.
Particularly important is that the SEC's statement directly addresses digital wallets and those trading digital assets. The SEC warns that digital wallet platforms providing services for digital assets deemed securities may trigger registration requirements under federal securities laws. Additionally, the SEC stated that any exchange dealing in digital assets that are deemed securities and not registered with the SEC may be participating in the unregistered offering and sale of securities.
The SEC has repeatedly made it clear that certain digital assets, such as tokens, may be securities and has warned issuers and advisers that they may face disciplinary action for evading securities laws.(3) However, this is the first time that the SEC has directly targeted exchanges and trading platforms in the context of virtual currencies and initial coin offerings. Exchange operators and digital wallet service providers should exercise caution in ensuring that no tokens exchanged or held on their platforms meet the definition of 'securities' under federal securities laws if they do not wish to register with the SEC, and any online trading platform that wishes to deal in securities tokens should comply with all federal securities regulations. Exchange operators and digital wallet service providers should also bear in mind that the SEC has repeatedly expressed a view that it would be very challenging to structure a token to not meet the definition of 'security'.(4)
For further information on this topic please contact Jay G Baris, Geoffrey B Goldman, Lona Nallengara or Donna M Parisi at Shearman & Sterling LLP by telephone (+1 212 848 4000) or email (email@example.com, firstname.lastname@example.org, email@example.com or firstname.lastname@example.org). The Shearman & Sterling LLP website can be accessed at www.shearman.com.
(1) SEC, "Statement on Potentially Unlawful Online Platforms for Trading Digital Assets" (March 7 2018), available here.
"any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange."
(3) See SEC "Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO", Exchange Act Release 81207 (July 25 2017), available here; and Chair Jay Clayton, SEC, "Opening Remarks at the Securities Regulation Institute" (January 22 2018), available here.
(4) See Chair Jay Clayton, SEC, "Chairman's Testimony on Virtual Currencies: The Roles of the SEC and CFTC" (February 6 2018), available here.
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