By Jacquelyn Lumb
Jay Clayton has emphasized that his focus as SEC chairman will be on capital raising and the protection of retail investors. Following a recent enforcement action against Munchee Inc. for an offering of digital tokens that constituted an illegal unregistered securities offering, Clayton released a statement in which he outlined his general views on cryptocurrency and the ICO markets. The SEC is committed to promoting capital formation, he said, and investors should be open to these opportunities, but they must ask good questions, demand clear answers and apply common sense.
For Main Street investors, Clayton advised that there is much less investor protection in the cryptocurrency and ICO markets than traditional markets, which creates more opportunities for fraud and manipulation. No ICOs have been registered with the SEC, and no cryptocurrency type products have been approved for listing and trading, he advised. In addition, the SEC has not approved for listing any exchange-traded products that hold cryptocurrencies or other assets related to cryptocurrencies.
In a footnote to his statement, Clayton noted that the CFTC has designated bitcoin as a commodity. He said that fraud and manipulation involving bitcoin which is traded in interstate commerce is appropriately within the purview of the CFTC, as is the regulation of commodity futures tied directly to bitcoin. However, products that are linked to the value of underlying digital assets, including bitcoin and other cryptocurrencies, may be structured as securities products subject to registration under the Securities Act or the Investment Company Act.
He urged investors to read the investor alerts, bulletins, and statements issued by the SEC regarding the marketing of these offerings. Because these instruments may trade on systems and platforms outside the U.S., Clayton said it heightens the risk that the SEC and other regulators may not be able to recover any lost funds.
For market professionals, including securities lawyers, accountants, and consultants, Clayton urged them to read the SEC’s Section 21(a) investigative report on The DAO that was issued on July 25, 2017. The report describes how the SEC applied longstanding securities law principles to demonstrate that a token was an investment contract, and therefore a security under the federal securities laws. Clayton said that offerings which incorporate features and marketing efforts that promote the potential for profits based on the efforts of others contain the hallmarks of a security. Market professionals should be guided by the intent of the SEC’s registration, offering process, and disclosure requirements, he said, which includes the protection of Main Street investors.
Before launching a cryptocurrency or a product with its value tied to cryptocurrencies, Clayton said that promoters must be able to demonstrate that the product is not a security or they must comply with the applicable registration and other requirements of the federal securities laws. Broker-dealers and other market participants that allow payments in cryptocurrencies, allow customers to purchase cryptocurrencies on margin, or otherwise use cryptocurrencies in securities transactions should exercise caution to ensure that they are not undermining their anti-money laundering or know-your-customer obligations, he added.
Clayton’s statement closed with a list of questions that investors may wish to consider before engaging in a cryptocurrency or an ICO investment opportunity. He has asked the Division of Enforcement to focus on this area and to bring enforcement actions when they find ICOs that violate the federal securities laws.