On January 14, 2020, the U.S. Securities and Exchange Commission (SEC) Office of Investor Education and Advocacy published an investor alert (Alert) regarding initial exchange offerings (IEOs), a type of digital asset fundraising facilitated by online trading platforms.1 Although the Alert is directed at investors, it provides important information to blockchain companies and trading platforms. The Alert highlights the following:
- an explanation of an IEO
- IEOs that are securities offerings must comply with federal securities laws
- a platform offering an IEO may need to register as a broker-dealer, national securities exchange or operate pursuant to an exemption, such as an alternative trading system (ATS)
- IEOs offered to U.S. investors, even if offered from outside the United States, must comply with federal securities laws
Initial Exchange Offerings. An IEO is the offer and sale of a digital asset to raise capital through an online trading platform. IEOs are the latest development in the evolution of digital asset distributions, which started in 2017 with initial coin offerings (ICOs), followed in 2018 and 2019 by security token offerings (STOs). IEOs are being used to raise capital and touted by trading platforms as an opportunity to immediately trade the digital assets. This is in contrast to other digital asset offerings, such as STOs, which have generally relied on an exemption from the registration requirements of the securities laws. The Alert urges investors to use caution when considering investing through an IEO.
Securities Offerings. The SEC explains that an IEO may be an offering of securities and thus subject to the registration requirements of the Securities Act of 1933 and Securities Exchange Act of 1934 (Exchange Act). The issuance of a security must be pursuant to a registration statement filed with the SEC unless an exemption is available.2 Even if there is no registration statement filed with the SEC, a security may need to be registered for it to trade on the secondary market.3 The Alert notes that IEOs may be used to entice investors with the false promise of high returns, while the federal securities registration requirements compel applicable issuers to provide certain disclosures so that investors may make informed investment decisions.4 The Alert points out that notwithstanding any statements by IEO promoters, “there is no such thing as an SEC-approved IEO.”
Broker-Dealers. Online trading platforms that facilitate IEOs may be acting as unregistered broker-dealers. Broker-dealers must register with the SEC and become a member of a self-regulatory organization such as the Financial Industry Regulatory Authority (FINRA). Registered broker-dealers are subject to requirements that function as important safeguards for investors, such as acting in a manner consistent with the SEC’s customer protection standards.
National Securities Exchanges. The Alert cautions that trading platforms offering IEOs may claim to perform quality assessments of the IEOs but are typically not registered with the SEC as is required under the Exchange Act by anyone claiming to be a securities “exchange.” Alternatively, a platform can operate pursuant to an exemption, such as the alternative trading system (ATS) exemption provided in Regulation ATS. ATSs must register with the SEC and join a self-regulatory organization, typically FINRA. The legal and regulatory requirements that apply to exchanges and ATSs are designed to protect investors and prevent fraudulent and manipulative trading practices.5
Offshore Offerings. Issuers and platforms based outside the United States must comply with U.S. securities laws if offers are being made to people within the United States. The SEC highlights as a red flag to investors if an offering purports to avoid the federal securities laws because it is conducted by a foreign entity or offshore trading platform but allows U.S. persons to invest.
Investors may not have the same legal remedies against offshore trading platforms or companies as they would with U.S. entities.
This Alert provides important information to trading platforms and blockchain companies that have conducted or are considering IEOs. As digital asset offerings have evolved from ICOs to STOs and beyond, the SEC has published investor alerts and bulletins regarding the application of securities laws to digital assets around the same time as other SEC releases involving similar issues. Digital asset trading platforms and blockchain companies should diligently consider the federal securities laws in any fundraising involving persons in the United States.
2 Securities Act of 1933, 15 U.S.C. § 77e.
3 Securities Exchange Act of 1934, 15 U.S.C. § 78l.
4 See our client updates: SEC FinHub’s Digital Asset Framework: A Guide for Issuers and Secondary Trading Markets and The Sheriffs are in Town: Recent Developments in Initial Coin Offerings (ICO) Enforcement and Investor Education.
5 See our client updates: Digital Asset Securities: Joint SEC and FINRA Statement Aimed at Broker-Dealer Custody and One-Two-Three Punch: SEC and FINRA Announce Actions Against Unregistered Broker, Digital Asset Manager and FINRA Registered Person.