Summary

Trading venues for blockchain tokens and other digital assets, such as exchanges and alternative trading systems and other liquidity providers are becoming subject to increased regulatory scrutiny from both federal and state regulators. The SEC and the New York Attorney General have directed their focus to digital assets exchanges, reminding both operators and users of trading platforms that such exchanges must fulfill all applicable registration and related regulatory requirements, and we expect other state regulators to follow suit.

McDermott Will & Emery law clerk Michael Wasenius also contributed to this article.

In Depth

As we anticipated in the January 10, 2018, McDermott Will & Emery On the Subject, titled Five Regulatory Implications for Blockchain Tokens as an ‘Asset Class,’ trading venues for blockchain tokens and other digital assets, such as exchanges and alternative trading systems and other liquidity providers are becoming subject to increased regulatory scrutiny from both federal and state regulators.

Securities and Exchange Commission Statement Warns Investors and Operators That Online “Exchanges” for Digital Assets May Need to Be Registered

The Securities and Exchange Commission (SEC) Divisions of Enforcement and Trading and Markets issued a Statement on Potentially Unlawful Online Platforms for Trading Digital Assets on March 7, 2018 (the SEC Statement). The SEC Statement addressed the use of online platforms as “exchanges” for cryptocurrencies and digital assets without proper registration as either a national securities exchange or an alternative trading system (an ATS). 15 U.S.C. § 78e. The SEC warned investors that platforms may be labeled as an “exchange,” and appear to be carrying out the functions of an exchange, but lack proper regulatory oversight.

In the SEC Statement, the SEC also offered guidance to market participants operating online trading platforms. An online trading platform that functions as an exchange for digital assets that may be classified as “securities” must register with the SEC as either a national securities exchange pursuant to Section 6(a) of the Securities Exchange Act or as an ATS pursuant to Regulation ATS. 15 U.S.C. § 78f; 17 C.F.R. § 240.3a1-1. In order to be registered as a national securities exchange, an operator must (1) satisfy all the regulatory requirements for registration as a national securities exchange, including designing rules to prevent fraudulent and manipulative acts on such exchange; (2) function as a self-regulatory organization which provides rules and procedures for monitoring and disciplining its members for violation of the securities laws or rules established by the exchange; and (3) maintain compliance with SEC requirements on an ongoing basis. Alternatively, an operator may rely on an exemption from registration as a national securities exchange pursuant to Regulation ATS. An ATS is exempt from national securities exchange registration, but must (1) register as a broker dealer, (2) join a self-regulatory organization (most commonly the Financial Industry Regulatory Authority) and (3) comply with the securities laws and member rules established by the self-regulatory organization.

The New York Attorney General’s Virtual Markets Launched an Integrity Initiative That Focuses on Digital Asset “Exchanges”

On April 17, 2018, The New York State Attorney General launched the Virtual Markets Integrity Initiative, and issued a statement titled “A.G. Schneiderman Launches Inquiry Into Cryptocurrency ‘Exchanges’” (as described therein, the Initiative), to investigate the policies and procedures of platforms exchanging digital assets and cryptocurrencies. The aim of the Initiative is to increase transparency and accountability in the market for digital assets and cryptocurrencies. The New York Attorney General has sent requests for information on the operations, internal controls and consumer protection efforts of platform operators to 13 virtual currency trading platforms. The request includes a questionnaire, available here, which covers six major categories: (1) Ownership and Control, (2) Basic Operation and Fees, (3) Trading Policies and Procedures, (4) Outages and Other Suspensions of Trading, (5) Internal Controls and (6) Privacy and Money Laundering. Through the questionnaire, the Attorney General “seeks to increase transparency and accountability in the virtual currency marketplace—and better inform the actions of enforcement agencies, investors, and consumers in this space.” A.G. Schneiderman Launches Inquiry Into Cryptocurrency “Exchanges” (Apr. 17, 2018). The Initiative makes clear that the Attorney General’s office is taking a very broad approach in investigating the digital asset platforms’ compliance with regulatory requirements and investor protection initiatives under New York State law. N.Y. Exec. Law § 63(12); N.Y. Gen. Bus. Law § 349; N.Y. Gen. Bus. Law § 352.

As described herein, both the SEC and the New York Attorney General have directed their focus to digital assets exchanges, reminding both operators and users of trading platforms that such exchanges must fulfill all applicable registration and related regulatory requirements. We expect other state regulators to follow suit. Market participants operating digital asset trading platforms or exchanges, and investors utilizing such platforms and exchanges should seek the advice of legal counsel to determine the applicable federal and state registration requirements.