On 14 January 2020 the US Securities and Exchange Commission (SEC) issued an Investor Alert on Initial Exchange Offerings (IEO). This Investor Alert represents the SEC's latest step to shine a light on cryptocurrencies and the methods used to offer them.

Background

Initial exchange offerings are token offerings conducted on the platform of a cryptocurrency exchange in much the same way that securities are offered on a securities exchange. Typically, as the token is listed on the exchange, the issuer pays a listing fee along with a percentage of the tokens sold during the offering period. In return, the tokens are sold via the platform and the coin is listed on the exchange after the IEO is over. Given that IEOs are a relatively recent development in the rapidly evolving digital asset space, most are not registered with the SEC.

SEC Concerns

Platforms offering IEOs may improperly refer to themselves as "exchanges," or claim to perform due diligence or other quality assessments of the IEOs. The SEC cautions that there are important issues investors should be aware of before investing in an IEO. As in the case of ICOs and STOs, depending on the facts and circumstances of the offering, the offering may involve the offer and sale of securities. This means that unless an exemption applies, the IEO may be subject to registration and other requirements under the Securities Act of 1933 that apply to offerings under the federal securities laws. Among other things, registration means that the company offering the digital asset has to provide important disclosures about itself, its business, the digital asset offered, and the terms of the offering to investors.

If an IEO or any other form of cryptocurrency offered on the exchange is considered a security then, absent an exemption, the platform will need to register as a national securities exchange. Platforms qualifying as Alternative Trading Systems can avoid this requirement by registering as brokers-dealers and joining a self-regulatory organization. Qualification as an ATS is generally for persons and systems that (1) constitute a market place for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly done by a stock exchange and (2) do not (i) set rules governing the conduct of subscribers other than the trading or (ii) discipline subscribers other than exclusion from trading.

Even if not considered an exchange, the online trading platform involved in an IEO may otherwise be acting as a broker or dealer and required to register with the SEC and become a member of a self-regulatory organization, like the Financial Industry Regulatory Authority. Finally, platforms subject to either of the above the above may also be considered fiduciaries under Regulation Best Interest and need to file a Form CRS with the SEC.

Next Steps

If you are operating a platform with IEOs or other cryptocurrency it is important to either consider the registration options outlined above or safeguard your platform from offering instruments which are considered securities to US investors. You should revise your operating and onboarding policies to be able to make a reasonable determination of the consideration of instruments offered on your platform. Cryptocurrency issuers should use caution when launching their tokens through an IEO, and understand that their obligations to comply with federal securities laws are not excused by offering the tokens on an exchange.

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