SEC's First Action Against Unregistered Crypto "Exchange"

Blockchain & E-Transactions Law

On November 8, the SEC filed its first settled enforcement action against a cryptocurrency trading platform for operating as an unregistered exchange trading securities, in violation of the Securities Exchange Act of 1934.

"EtherDelta" was a platform offering matched-book secondary market trading of ERC-20 tokens, many of which had issued in unregistered initial-coin-offerings ("ICOs") having attributes of "securities" under the Howey investment-contract analysis. The Howey test was applied by the SEC in its July 2017 Section 21A Report, The DAO, to conclude that digital assets (tokens) in ICOs are "securities" where they involve:

• An investment of money
• In a common enterprise
• With an expectation of profits
• From the entrepreneurial or managerial efforts of others.

See Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Rel. No. 34-81207 (SEC July 25, 2017), here.

The SEC felt that The DAO § 21A Report offered sufficient warning, especially since over 90% of the trading on EtherDelta occurred after July 2017 and many involved ICOs deemed "securities."

The SEC's Order contains significant explanatory detail about EtherDelta's operations and stakes a position on cryptocurrency trading platforms. The Order's paragraph 26 on the Howey analysis arguably goes an unnecessary bridge too far, however, insofar as might be read to suggest that the trading platform itself might be a "security" (instead of merely those digital assets traded on it):

"During the Relevant Period, EtherDelta operated as a marketplace for bringing together the orders of multiple buyers and sellers in tokens that included securities as defined by Section 3(a)(10) of the Exchange Act. The purchasers of such digital tokens invested money with a reasonable expectation of profits, including through the increased value of their investments in secondary trading, based on the managerial efforts of others. See DAO Report; SEC v. Edwards, 540 U.S. 389, 393 (2004); SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946)."

Order at 26.

The Commission cited EtherDelta's operator's prompt remediation and cooperation "facilitat[ing] the staff's investigation involving an emerging technology" as a reason for not imposing sanctions beyond the $300,000 disgorgement and $75,000 civil monetary penalty, In the Matter of Zachary Coburn, Rel. No. 34-84553 (SEC Nov. 8, 2018), here.

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