On Tuesday May 4, the Securities and Exchange Commission announced its plan to nearly double its Enforcement Division's Digital Asset and Cyber Security Unit, which is tasked with protecting "investors in crypto markets and from cyber-related threats." The announcement comes after SEC Chair Gary Gensler stated in 2021 that the SEC needed more resources to protect investors in the "growing and volatile" digital assets sector.
The SEC's announcement referred to "polic[ing] wrongdoing in the crypto markets" and protecting retail investors who the SEC stated have been "bearing the brunt of abuses in this space." The announcement also referred to the SEC's 80 enforcement actions and $2 billion in recovered monetary relief since 2017, from actions relating to fraudulent and unregistered crypto asset offerings and platforms. It is intended that the 20 additional positions will grow to 50 positions, and will include investigative staff attorneys, trial counsels, and fraud analysts.
The size and nature of the SEC's appointments should act as a stark reminder that participants in the digital asset industry must comply with all applicable laws. Reliance on industry standards is unlikely to protect participants from enforcement actions and lawsuits. For example, participants should heed the SEC’s advice that “those who would use a Decentralized Autonomous Organization (“DAO Entity”), or other distributed ledger or blockchain-enabled means for capital raising, [should] take appropriate steps to ensure compliance with the U.S. federal securities laws.”
A project has several options when crafting a legal strategy for complying with federal securities laws. The safest options are to (1) register securities transactions with the SEC, or (2) issue securities pursuant to an exemption from the registration requirement. Alternatively, projects may (3) ensure that their tokens, by their design and the relationships they embody, are utility tokens in nature as well as in name. Further, projects may (4) "sufficiently decentralize” their decision-making structures and maximize the role of all participants in a project.
The latter two options require careful considerations of a token’s technical architecture and the intent of purchasers of the tokens, even if the token has utility. Further, the SEC has not provided any official guidance on if/how a token can avoid being a security while still offering some tangential investment opportunity, nor what stage of decentralization a token must reach to no longer be deemed a security.
The Securities & Capital Markets and the Blockchain, Digital Currencies & Smart Contracts teams at Michael Best have attorneys who are experienced in helping projects navigate the nuances in how securities laws apply to tokens. Please do not hesitate in reaching out to a member of our team.