On November 8, 2018, the U.S. Securities and Exchange Commission (SEC) announced settled charges against Zachary Coburn, the founder of EtherDelta, for operating a national securities exchange without registration in violation of Section 5 of the Securities Exchange Act of 19341. EtherDelta is an online platform used for secondary market trading of ERC20 tokens, common ethereum-based tokens. This is the first SEC enforcement action based on the finding that a token trading platform was an unregistered national securities exchange. Industry observers expect more such enforcement actions to come.
Relying on the DAO Report2 issued on July 25, 2017 that applied the Supreme Court’s definition of investment contract in SEC v. W.J. Howey Co.3 to certain tokens, the SEC determined that EtherDelta offered trading of various digital asset securities and failed to register as an exchange or operate pursuant to an exemption from federal securities laws.
The SEC’s press release regarding the settlement stated that EtherDelta’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. Because of these characteristics, SEC Co-Director of the Division of Enforcement, Stephanie Avakian, stated that “EtherDelta had both the user interface and underlying functionality of an online national securities exchange and was required to register with the SEC or qualify for an exemption.”
Without admitting or denying the SEC’s findings, Coburn consented to the SEC’s order and agreed to pay $300,000 in disgorgement plus $13,000 in prejudgment interest and a $75,000 civil monetary penalty.
If you have any questions about when operating a trading platform could run afoul of applicable securities laws, rules or regulations, please speak with your S&K contact attorney or any member of our Blockchain and Cryptocurrency Group.
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1 15 U.S.C. § 77e.
2 See Seward & Kissel Client Alert, “SEC Speaks Out on ICOs, Cautions That Some May Involve Offering of Unregistered Securities,” July 27, 2017, https://www.sewkis.com/publications/sec-speaks-out-on-icos-cautions-that-some-may-involve-offering-of-unregistered-securities/.
3 SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
