Crypto exchanges in SEC cross-hairs

The SEC has continued its guidance relating to all things crypto with a statement in early March regarding the legality of exchanges. While the statement doesn’t name any specific exchanges, it does make it clear the SEC considers many exchanges to be acting contrary to US securities law by trading assets the SEC considers to be securities.

Attorney Nimish Patel, a securities expert with law firm Mitchell Silberberg & Knupp says the SEC “wants to prohibit retail investors from investing in the super risky cryptocurrencies, and the most effective way to do this is to cut off their ability to buy and sell by taking down the exchanges.” Patel says for the SEC to go after individual ICOs and cryptocurrencies would be too time consuming, and instead the agency hopes a more effective strategy would be to target the exchanges (which the SEC calls “Online Trading Platforms”) and thus shut down the supply chain."

While he notes that the SEC doesn’t typically have a problem with accredited investors buying cryptocurrencies, he says it is concerned about what happens when those investors decide to liquidate their crypto assets. “It doesn’t want accredited investors flipping cryptocurrencies to unaccredited investors. Since the exchanges currently allow for this to happen, the SEC wants them regulated.”

In its statement the SEC said:

Online trading platforms have become a popular way investors can buy and sell digital assets, including coins and tokens offered and sold in so-called Initial Coin Offerings ("ICOs").  The platforms often claim to give investors the ability to quickly buy and sell digital assets. Many of these platforms bring buyers and sellers together in one place and offer investors access to automated systems that display priced orders, execute trades, and provide transaction data.

A number of these platforms provide a mechanism for trading assets that meet the definition of a "security" under the federal securities laws.  If a platform offers trading of digital assets that are securities and operates as an "exchange," as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration.  The federal regulatory framework governing registered national securities exchanges and exempt markets is designed to protect investors and prevent against fraudulent and manipulative trading practices.

Considerations for Investors Using Online Trading Platforms

To get the protections offered by the federal securities laws and SEC oversight when trading digital assets that are securities, investors should use a platform or entity registered with the SEC, such as a national securities exchange, alternative trading system ("ATS"), or broker-dealer.

The SEC staff has concerns that many online trading platforms appear to investors as SEC-registered and regulated marketplaces when they are not. Many platforms refer to themselves as "exchanges," which can give the misimpression to investors that they are regulated or meet the regulatory standards of a national securities exchange.  Although some of these platforms claim to use strict standards to pick only high-quality digital assets to trade, the SEC does not review these standards or the digital assets that the platforms select, and the so-called standards should not be equated to the listing standards of national securities exchanges.  Likewise, the SEC does not review the trading protocols used by these platforms, which determine how orders interact and execute, and access to a platform’s trading services may not be the same for all users.

Again, investors should not assume the trading protocols meet the standards of an SEC-registered national securities exchange.  Lastly, many of these platforms give the impression that they perform exchange-like functions by offering order books with updated bid and ask pricing and data about executions on the system, but there is no reason to believe that such information has the same integrity as that provided by national securities exchanges.

Although stated SEC positions are frequently a reference point for other securities regulators internationally, its jurisdiction only applies directly in the United States. Dasset CEO Stephen Macaskill says regulators often walk a fine line between trying to protect retail investors and not get in the way of economic growth. "Innovation in this space is not slowing down," he says, "and the SEC might push innovation and jobs offshore if they have a blanket approach that stifles accelerating innovation — the results of a one-size-fits-all approach could end up with the United States losing its position as the financial capital of the world."