The SEC announced two similar enforcement actions on September 11, both relating to failures to register by market intermediaries in connection with their digital asset activities. The lesson learned from both of these actions is that digital asset issuers are not the only ones who need to be aware of the securities laws – market intermediaries dealing in digital assets may also have registration and customer protection obligations, and failure to observe these requirements can result in serious penalties.
The first case marks the SEC’s first-ever finding that an intermediary for digital token sales failed to register as a broker-dealer. TokenLot and its founders promoted TokenLot as an “ICO Superstore” allowing investors to make primary purchases in ICOs and conduct secondary trading. The SEC emphasized that TokenLot continued to operate after the SEC issued its Section 21(a) report on “The DAO,” concluding that DAO tokens were securities and cautioning market participants that many ICO tokens could be considered securities.
The SEC’s release regarding this case notes that TokenLot and its founders cooperated with the SEC’s investigation. However, TokenLot and its founders still agreed to pay $471,000 in disgorgement plus $7,929 in interest, and were required to retain an independent third party to destroy TokenLot’s remaining inventory of digital assets. The founders also agreed to pay penalties of $45,000 each and agreed to industry and penny stock bars and an investment company prohibition with the right to reapply after three years.
The second case marks the SEC’s first-ever finding of an investment company registration violation by a hedge fund. Crypto Asset Management LP (CAM) is a hedge fund that raised $3.6 million in four months to invest, in large part, in digital assets. CAM falsely claimed in its offering material that the fund/offering was registered and regulated by the SEC. The SEC did not take kindly to this misrepresentation and CAM’s avoidance of registration, and fined CAM $200,000. In addition, similar to other entities who have been reined in for failure to comply with registration requirements, CAM was required to cease the offering and provide buybacks to affected investors.
Understanding CAM’s thought processes, especially in light of prior enforcement cases, is challenging. What is clear, however, is that the SEC’s Enforcement Division will continue to aggressively pursue such cases, and that those who seek the rewards of participating in token-related offerings are very much in the SEC’s crosshairs.
In another action, a registered broker-dealer and investment advisor, Cadaret, Grant & Co. Inc. was charged with sales of an unsuitable product and failure to supervise. The SEC emphasized the firm’s failure to adequately research the product’s risks and analyze for whom it was intended, resulting in mistaken buy and hold recommendations by brokers for a product designed to be held for less than a day by sophisticated investors. The SEC imposed sanctions aggregating $925,000 on the firm, two of its principals and one of its brokers.
Although this third action related to a leveraged oil-linked exchange-traded note and not digital tokens, the lesson is an important one for participants in the token space. In the rush to sell the hottest new thing in investment products, firms cannot forget basic principles of required new product review. Is the product suitable for anyone; if so for whom; and what are the product’s features and risks? In this case, where the losses equaled 1.5 percent of the sanctions imposed, the SEC has sent a loud and clear message to broker-dealers and investment advisers hopping on the token train.