The Security Token Story: SEC Reveals Act III — Registered Digital Assets — and Reminds Market Actors of Acts I (Investment Vehicles) & II (Secondary Trading)

On November 16, the U.S. Securities and Exchange Commission (SEC) announced its first enforcement actions against issuers of initial coin offerings solely for failing to register the offerings in violation of the federal securities laws since Munchee (i.e., without allegations of fraud). Unlike the Munchee order, these settlements impose penalties against the issuers and require certain undertakings, such as registering the digital assets as securities under the Exchange Act. The same day, the SEC’s Divisions of Corporation Finance, Investment Management and Trading and Markets released a joint statement reiterating the SEC’s lessons from recent enforcement actions related to digital assets.

Two recent enforcement actions and a joint statement add to the U.S. Securities and Exchange Commission’s (SEC or Commission) guidance on digital asset securities:

  • On November 16, the Commission announced its first settlements imposing registration requirements and civil penalties against issuers of initial coin offerings (ICOs) solely for failing to register their respective offerings under Section 5 of the Securities Act of 1933 (Securities Act) without allegations of fraud. The respondents in In the Matter of CarrierEQ, Inc., D/B/A Airfox (Airfox Order) and In the Matter of Paragon Coin, Inc. (Paragon Order, together the Orders) agreed to settle the registration charges, register the tokens as securities and offer refunds to investors.
  • On the same day, the SEC’s Divisions of Corporation Finance, Investment Management and Trading and Markets released a joint Statement on Digital Asset Securities Issuance and Trading (Joint Statement) highlighting recent enforcement actions and reiterating their views on three key areas related to digital asset securities:
    • Corporation Finance: Initial offers and sales of digital asset securities (including those issued in ICOs) must be conducted in accordance with the federal securities laws. The recent enforcement cases show that there is a path to compliance even where issuers conducted an illegal unregistered offering of digital asset securities.
    • Investment Management: Investment vehicles investing in digital asset securities must comply with an established registration and regulatory framework when investing in or advising on investments in digital asset securities.
    • Trading and Markets: Secondary market trading of digital asset securities must be conducted in accordance with the SEC’s registration requirements for broker-dealers, national securities exchanges and/or alternative trading systems.

These recent SEC enforcement actions and the Joint Statement provide further clarity on digital asset securities, including how those who conducted ICOs may offer rescission to investors, but questions remain.

Act III: Registered Security Tokens 

The Paragon and Airfox Orders are the first enforcement actions against issuers of blockchain tokens in an ICO for violating the registration requirements of the federal securities laws, in the absence of allegations of fraud, since Munchee.1 Notably, and unlike Munchee, these settlements impose civil penalties on the issuers and require the issuers to undertake remediation efforts that include registration of the tokens as securities under the Securities Exchange Act of 1934 (Exchange Act). The SEC determined that Paragon Coin, Inc.’s (Paragon) and CarrierEQ, Inc.’s (Airfox) ICOs and token pre-sales constituted the offer and sale of securities under the Securities Act. As first noted in the DAO Report, and reaffirmed in subsequent SEC enforcement actions, the Howey test is the governing law that applies to determine whether the offer and sale of ICOs or tokens are “investment contracts” subject to U.S. securities laws and therefore should be offered pursuant to SEC registration requirements (or an exemption therefrom).2  

ICOs. According to the SEC’s orders, Paragon and Airfox marketed and sold their tokens in 2017 after the SEC published the DAO Report. Paragon was established to deploy a suite of blockchain-enabled products to organize, systematize and bring verification and stability to the cannabis industry. Airfox sells mobile technology that allows customers to earn free or discounted airtime or data by watching advertisements on their smartphones. Key features of the ICOs and digital assets included:

  1. “Ecosystems.” According to the Orders, Airfox and Paragon conducted ICOs to fund the development of their product “ecosystems.”
  2. Marketing. Airfox and Paragon published whitepapers detailing the features of their tokens, expected use of ICO and presale proceeds and a timeline for development of their “ecosystems.” Executives and paid promoters of each company publicly marketed their tokens on social media. Paragon hired a celebrity to promote its token, subsequent to the SEC’s public statements on the topic.3 Airfox aimed its promotional efforts to digital asset investors rather than their target user base.
  3. Active Measures to Increase Price. Each company announced plans to reduce the number of available tokens in order to increase the demand and/or price for the tokens.
  4. Pre-sales. Each company sold tokens to certain early purchasers at a discount to the price set for the general public in the ICO.
  5. Secondary Trading. Each company announced that it will actively seek listing of the tokens on secondary market exchanges.

Registration. As part of their settlements with the Commission, Airfox and Paragon agreed to file a Form 10 with the SEC within 90 days to register their tokens as a class of securities under the Exchange Act and to thereafter make all required filings under the Exchange Act (until eligible to terminate such registration). Such registration and periodic reporting will provide the token purchasers the benefit of receiving disclosures as required by the Exchange Act. Given that no security token has yet been registered under the Exchange Act, it is not clear from the Orders what information the issuers will be required to provide in these disclosures.

Rescission. The settlements included an obligation for the companies to offer rescission rights in the form of refunds to token purchasers who had purchased tokens in the presale or ICO. The Orders detail several milestones that the companies will need to meet, including (i) distributing an SEC-approved claim form to allow investors to request a refund, (ii) refunding the consideration paid for the tokens plus interest less the amount of any income received thereon and (iii) providing the SEC with monthly reports on the progress of the rescission program.


With the Airfox and Paragon settlements, the SEC has provided a road map of sorts for remediation efforts for those who conducted ICOs in violation of the securities laws. The Joint Statement emphasizes that the Exchange Act undertakings are designed to ensure that investors receive the type of information they would have received had these issuers complied with the registration provisions of the Securities Act prior to the offer and sale of tokens in their respective ICOs. The Joint Statement further explains that the ongoing disclosure provided by registration under the Exchange Act will allow investors who purchased the tokens from the issuers in the ICOs to be able to make a more informed decision as to whether to seek reimbursement or continue to hold their tokens.

However, questions remain:

Registration. To date, no registration statement for the offer and sale of blockchain tokens has been declared effective under the Securities Act, and no offering circular has been qualified under Regulation A. Those attempting to register or qualify their offerings will need to work with the SEC staff (Staff) to address several open questions, including whether the token itself represents a financial instrument such as equity or debt or rather represents a non-financial instrument offered pursuant to an investment contract.

Rescission. Airfox and Paragon sold their tokens in exchange for ether, bitcoin and other cryptocurrencies. It is unclear how the refunds will be distributed, including the form of payment (cryptocurrency or fiat) and the valuation for the refund payment (at the time of purchase or time of refund).

Implications for Other ICOs. According to the SEC’s Co-Director of the Division of Enforcement, Steven Peikin, the Airfox and Paragon Orders provide a model for other companies that have issued tokens in violation of the federal securities laws. Will these companies follow suit in offering rescission and registering under the Exchange Act? With an estimated 1,450 ICOs conducted to date, how will the Staff handle the need to review the rescission programs and Exchange Act filings for potentially hundreds of issuers?

Acts I and II: Investment Vehicles & Investment Advisors and Trading 

As reiterated in the Joint Statement, the securities laws apply to investments by asset managers and secondary trading venues designed for trading digital asset securities. The Joint Statement reminds market actors that investment vehicles that hold digital asset securities and those who advise third parties about investing in digital asset securities must be mindful of the registration, regulatory and fiduciary obligations under the Investment Company Act of 1940 and the Investment Advisors Act of 1940.4  

Furthermore, the Joint Statement reminds market actors of the recent enforcement action against the founder of EtherDelta, underscoring the Division of Trading and Markets’ concerns about the failure of platforms that facilitate trading in digital asset securities to register as national securities exchanges absent an exemption from registration.5  The Joint Statement, citing the recent TokenLot order, reminds those who may be engaging in broker or dealer activity that they must register with the SEC and become members of a self-regulatory organization, typically the Financial Industry Regulatory Authority (FINRA).6 Lastly, the footnotes to the Joint Statement remind market participants that other potential legal and regulatory considerations may arise for entities engaging in digital asset activities, such as clearing agency and transfer agent registration requirements.


The SEC has been, and continues to be, focused on promoting innovation with respect to digital assets while balancing the need to protect investors. The undertakings required in these latest orders indicate that the SEC will allow the tokens or coins issued in unregistered, illegal offerings to remain outstanding, even though the issuer will need to conduct a rescission offer. Exchange Act reporting by issuers of these digital asset securities will be one more step forward in terms of regulatory acceptance. As always, market participants should be thoughtful in assessing the regulatory implications prior to launching or partnering with any digital asset project.

1. In the Matter of Munchee Inc., Securities Act Release No. 10445, December 11, 2017.
2. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Rel. No. 81207 (July 25, 2017) (DAO Report). Under the test laid out by the Supreme Court, a transaction is an investment contract if there is an investment of money in a common enterprise with the expectation of profit derived from the efforts of others. SEC v. W. J. Howey Co., 328 U.S. 293 (1946).
3. SEC Statement Urging Caution Around Celebrity Backed ICOs, November 1, 2017.
4. In the Matter of Crypto Asset Management, L.P. See the Sidley Update: One-Two-Three Punch: SEC and FINRA Announce Actions Against Unregistered Broker, Digital Asset Manager and FINRA Registered Person.
5. In the Matter of Zachary Coburn. See our prior Sidley Update: First SEC Enforcement Action Against Decentralized Digital Asset Exchange Echoes Recent Public Statements.
6. In the Matter of TokenLot, LLC et al. See the Sidley Update:One-Two-Three Punch: SEC and FINRA Announce Actions Against Unregistered Broker, Digital Asset Manager and FINRA Registered Person.