On November 8, 2018, the SEC announced settled charges against an unlicensed digital token exchange (the "Platform"). It represents the SEC's first enforcement action based on findings that such a platform operated as an unregistered national securities exchange. This action follows first-of-their kind enforcement actions that the SEC brought in September against an unregistered broker-dealer and an unregistered investment company that each transacted in digital securities.

According to the SEC's order, the Platform provided online secondary market trading of ERC20 tokens, a type of blockchain-based token commonly issued in ICOs. The SEC found that almost all of the orders placed through the Platform were traded after the SEC issued its 2017 DAO Report, which concluded that certain digital assets were securities and that platforms that offered trading of these digital asset securities would be subject to the SEC's requirement that exchanges register or operate pursuant to an exemption. Notably, over an 18-month period, the SEC determined that the Platform's users executed more than 3.6 million orders for ERC20 tokens, including tokens that are securities under the federal securities laws.

The federal securities laws provide a functional test to assess whether a trading system meets the definition of an "exchange" and must therefore register with the SEC. Under the test in SEC Rule 3b-16, an organization, association or group of persons is considered to constitute, maintain or provide a marketplace or facilities for bringing together purchasers and sellers of securities, or for otherwise performing with respect to securities the functions commonly performed by an exchange if such an organization, association or group of persons: (1) brings together the orders for securities of multiple buyers and sellers; and (2) uses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of the trade. The primary exemption from registration is for so-called alternative trading systems ("ATSs"). SEC Rule 3a1-1(a)(2) exempts from the definition of "exchange" any organization, association or group of persons that complies with Regulation ATS. Regulation ATS in turn requires an ATS to, among other things, register as a broker-dealer, file a Form ATS with the SEC, and establish written safeguards and procedures to protect subscribers' confidential trading information. An ATS that complies with Regulation ATS and otherwise complies with the other applicable SEC regulations need not register as a national securities exchange.

Here, the SEC's order found that the Platform operated as an unregistered national securities exchange that neither registered as an exchange nor operated pursuant to the ATS exemption (or any other available exemption). Specifically, the Platform provided a marketplace for bringing together buyers and sellers for digital asset securities through the combined use of an order book, a website that displayed orders and a smart contract run on the Ethereum blockchain. The Platform's smart contract was coded to validate the order messages, confirm the terms and conditions of orders, execute paired orders, and direct the distributed ledger to be updated to reflect a trade.

Without admitting or denying the findings, the Platform's operator agreed to pay $300,000 in disgorgement plus $13,000 in prejudgment interest and a $75,000 penalty. The SEC's order recognized his cooperation with the agency's investigation, which the SEC considered in determining not to impose a greater penalty.

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