Yesterday, in what may be the least surprising news of the year to securities lawyers, the SEC confirmed two things: first, digital assets and tokens are securities under US law and, second, exchanges and platforms that trade them need to register in order to operate legally in the United States. You can read the press release here. The findings provide clear guidance on how tokens will be regulated and they have broad implications for token issuers, exchanges, platforms, and blockchain companies of all stripes. My initial thoughts on the report are as follows:
• This report should not be read narrowly as only applying to the DAO and to other DAO like constructs. This is a stake in the ground – a broad statement of jurisdiction over the entire ecosystem. If you are going to issue, trade, sell, own, and otherwise exchange a digital asset in the US you need to now do so in accordance with SEC regulations.
• Many initial reactions to the report state that the ruling applies to “some” tokens not “all” tokens. In my opinion, this is a fundamental misreading of the action that can lead token issuers down a dangerous path. This take implies that the agency created an exemption to registration for some tokens. They, in fact, did the opposite and imposed a burden on issuers to determine, prior to the issuance, whether their token meets an existing exemption to registration.
• Once this burden is imposed, issuers need to realize two often misunderstood facts about the SEC (and American administrative law in general): first, once you receive an action from the agency you are guilty until proven innocent and, second, the agency operates with 20/20 hindsight.
• When the SEC decides it wants to examine the “facts and circumstances” around a particular offering or entity it does not engage in polite academic debate. It charges you, sometimes criminally, and begins to dig into your life with the full investigatory power of the US Government at its back. You need to, while under subpoena and subject to perjury, convince the agency that your “full stack, blockchain, token, file store, p2p, etc.” somehow exempts you from registration.
• And then…they can simply disagree. They can do so retroactively despite any best effort to design an exempt token. If you design and issue a token under the hope that the facts and circumstances around the issuance will be embraced by the SEC and exempted you are taking a massive risk.
• Another overlooked aspect of the ruling deals with exchanges and the buying and selling of tokens that do not meet SEC rules. The report concludes that exchanges must register and individuals who sell unregistered tokens can face liability. As I stated earlier, these findings are deliberately sweeping and meant to apply to the entire crypto-currency space.
• Finally, this also opens the door for private class action lawsuits that have nothing to do with an SEC enforcement action. Plaintiffs’ lawyers can now walk into court with the full knowledge that the SEC has established tokens as securities and will begin to sue the teams who issued them for securities fraud. This will accelerate as tokens get delisted from exchanges and become worthless.
The irony of this is twofold. First, the killer KYC/AML application may now be directed at keeping US citizens out of token offerings and, second, to avoid all this, all you have to do is work with a lawyer to structure an exempt offering or file a registration statement. Sophisticated token issuers will raise adequate funds to do so and will, as a result, capture market share.