On November 8, 2018, the U.S. Securities and Exchange Commission (the “SEC”) settled its first case against an unregistered cryptocurrency exchange. Zachary Coburn, founder of EtherDelta, agreed to pay $313,000 in disgorgement and interest, along with a civil fine of $75,000, in order to settle SEC allegations that EtherDelta was acting as an unregistered securities exchange.
In its Order Instituting Cease-and-Desist Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing a Cease-and-Desist Order, the SEC found that EtherDelta was effecting and reporting transactions in securities. EtherDelta, an online platform running on the Ethereum blockchain, matched buyers and sellers of Ether and “ERC20” digital assets. EtherDelta also provided access to the EtherDelta order book, and displayed bids and offers by symbol, price, and size. The SEC considers ERC20 tokens to be securities because the purchasers of ERC20 tokens invested money with a reasonable expectation of profits, including through trading on the secondary markets, based on the managerial efforts of others.
The SEC then applied the functional test laid out in Exchange Act Rule 3b-16(a) in determining that EtherDelta met the definition of exchange under Section 3(a)(1) of the Exchange Act. Specifically, EtherDelta operated as a market place for bringing together order of multiple buyers and sellers in securities by (1) bringing together the orders for ERC20 digital assets of multiple buyers and sellers and (2) using established, non-discretionary methods under which such orders—which were entered by buyers and sellers who agreed to the terms of the trade—interacted with each other. The SEC also concluded that no exclusion from the definition of “exchange” applied.
Accordingly, the SEC alleged that EtherDelta violated Section 5 of the Exchange Act through its operation as a national securities exchange and Zachary Coburn, who exercised complete and sole control over EtherDelta, caused such violation.
Those who operate or wish to operate platforms that match buyers and sellers of cryptocurrency or tokens that may be considered securities by the SEC should take note of this settlement, the first since the DAO Report. The SEC is continuing its effort to set clear boundaries governing the kinds of entities, products, and activities that must comply with SEC registration requirements. An entity that operates or is contemplating operating a similar platform should evaluate its product offering and make a determination as to whether they are similarly operating an exchange for the purchase and sale of securities. Reed Smith stands ready to assist its clients in conducting analyses and making such determinations.
The case is In the Matter of Zachary Coburn, Exchange Act Release No. 84553 (Nov. 8, 2018), and a copy of the Order may be found here.