On November 8, 2018, the SEC announced it had settled charges against Zachary Coburn, the founder of EtherDelta, a digital “token” trading platform. The SEC noted that its claims against Coburn were the first by the agency “based on findings that such a platform operated as an unregistered national securities exchange.” The settlement with Coburn comes a few weeks after the SEC announced it had issued cease and desist orders to a hedge fund manager, Crypto Asset Management LP (“CAM”), its principal, Timothy Enneking, and a self-proclaimed “ICO Superstore” named TokenLot LLC, and TokenLot’s principals. CAM allegedly raised millions from investors to invest in cryptocurrencies without filing a registration statement with the agency, while TokenLot allegedly offered users the ability to purchase digital tokens and then trade those tokens on a secondary market. Industry players should note that the Coburn, CAM, and TokenLot enforcement actions represent an anticipated expansion of the SEC’s regulatory activity into the secondary trading markets for digital tokens and cryptocurrencies arena. But industry players should also note that these enforcement actions may also foreshadow a growth in private litigation in the digital asset and cryptocurrency industry. Token issuers, people who advise issuers, people who invest on an institutional scale, as well as those who facilitate trading should thus consider not only how to minimize the risk of regulatory action, but also how to mitigate the risks of private, civil litigation.

According to the SEC, “EtherDelta provided a marketplace for bringing together buyers and sellers for digital asset securities through the combined use of an order book, a website that displayed orders, and a ‘smart contract’ run on the Ethereum blockchain.” The SEC asserted that over an 18-month period, “EtherDelta’s users executed more than 3.6 million orders for ERC20 tokens,” digital assets that are created and tracked using Ethereum’s technology platform. Almost all of the orders placed through EtherDelta filled after the SEC issued its 2017 DAO Report, which concluded that most digital tokens bear the hallmarks of a security under U.S. law. The SEC thus concluded “that platforms that offered trading of these digital asset securities would be subject to the SEC’s requirement that exchanges register or operate pursuant to an exemption.” Unlike many other enforcement actions, notably absent from the Coburn order matter was any allegation of fraud.

With regard to CAM, the SEC alleged that CAM and its principal, Enneking, “raised more than $3.6 million over a four-month period in late 2017 while falsely claiming that the fund was regulated by the SEC and had filed a registration statement with the agency.” While the matter involved allegations of untrue statements by CAM, it was not just the false representations that got CAM and Emmeking in trouble. The SEC also alleged that “[b]y engaging in an unregistered non-exempt public offering and investing more than 40 percent of the fund’s assets in digital asset securities, CAM caused the fund to operate as an unregistered investment company.”

TokenLot allegedly promoted its website “as a way to purchase digital tokens during initial coin offerings (ICOs) and also to engage in secondary trading.” According to the SEC, TokenLot dealt with more than 200 different digital tokens, some of which the SEC determined were securities. The SEC concluded that because TokenLot was receiving orders from retail investors to transact and trade in securities, TokenLot and its principals should have registered with the SEC as broker dealers. In its press release announcing the TokenLot order, the SEC encouraged those who dealt in digital tokens to contact the SEC staff to analyze issues relating to registration.

The enforcement actions against Coburn, CAM, and TokenLot could have been expected given the SEC’s view on digital tokens and ICOs. Indeed, the SEC has repeatedly said that while not all digital tokens are securities, they have yet to find a digital token that is not a security. Thus, the recent regulatory enforcement activity should continue to create concerns over enforcement for anyone in the digital asset and cryptocurrency industry who offers, sells, advises on, trades, or invests in digital assets. What remains to be seen, however, is whether private litigation will follow. But if history is any guide, it shows that where the regulators have been active, private plaintiffs will soon follow. Those in the industry should thus consider how to mitigate the risks of private, civil litigation. Mitigation measures might include more robust disclosures, choice of law provisions, damages waivers, class-action waivers, and/or arbitration provisions in their contracts.