Demand for all things crypto remains high, and financial outcomes for crypto enterprises have been described as “astronomical”. Robinhood stands out as a prime example.
The mobile trading app quadrupled its market valuation in less than a year due in part to their new cryptocurrency exchange. It was an overwhelming success with more than a million pre-launch account applications within five days of program announcement.
Rewards and challenges are two sides of the same coin. Crypto executives will need to overcome some tough regulatory obstacles before they can reap these rewards. Compliance experts point out two key areas of concern: intense regulatory scrutiny, and regulatory enforcement policies that continue to evolve over time.
Intense Regulatory Scrutiny
The Securities and Exchange Commission (SEC) is keeping a close watch on every aspect of crypto, and their new Cyber Unit is aggressively targeting cyber-related misconduct. According to a senior official, “...there are dozens of open investigations into ICOs.”
In a recently published Public Statement on Potentially Unlawful Online Platforms for Trading Digital Assets they asserted, “If a platform offers trading of digital assets that are securities and operates as an exchange, as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration.”
Some analysts believe the SEC intends to take it a step further. Scott Purcell, the CEO of FundAmerica states in What Have ICOs Become, “The SEC is now saying pretty much all ICO’s are securities offerings (and therefore all coins are securities), and subject to their rules and regulations.” According to this interpretation, the SEC would treat all cryptocurrencies as security tokens, making the distinction between a security token and a utility token a moot point. All ICOs, cryptocurrency coins and crypto exchanges would need to comply with SEC regulatory guidelines.
Regulatory agency announcements, in combination with a frenzied press, are making it more difficult for crypto companies to advertise on social media platforms. Facebook banned all crypto ads from their platform in January. And Google will stop accepting any ads related to cryptocurrencies as of June. This ban will include ICOs, coin wallets and trading advice.
Same SEC Rules, Different Enforcement Policy
The Public Statement referenced above may look like the SEC has issued new guidelines.
It’s important to remember that regulatory agency guidelines are not a static set of black-and-white rules. Regulatory administration is a process. The agencies start with a set of broadly outlined rules designed to cover a range of anticipated and unanticipated outcomes. Then the enforcement of those rules evolves in reaction to changes in the marketplace. Compliance experts see regulators fine tune their enforcement policies on a regular basis.
The SEC’s current position is just the latest calibration as they work to manage an innovative financial category that changes direction on an almost daily basis.
Immunize Your Crypto Enterprise
Cryptocurrency analysts may be debating whether the SEC would be guilty of overreach, if they enforce policies in a way that makes every crypto a security token. Compliance experts will tell you it’s not a good idea to develop a fintech business in a vacuum, and then hope to defend your position during a regulatory review. It pays to use a sandbox approach where you partner with your regulatory counterpart as you develop product features and technical functionality.
The goal is to inoculate your crypto program from a potential enforcement action. The sandbox approach helps to prevent any regulatory consequences. It also creates a basis for managing the review process to a positive outcome in case of an audit.
There are both federal level and state level regulations that must be considered.
According to the current SEC guidelines all crypto exchanges located or operating in the US are required to be registered with the SEC, or to be exempt from registration. There are a number of ways to become exempt from SEC registration. The most common approach is to file with the SEC as an alternative trading system (ATS), which would include becoming an online broker-dealer (BD) as well as a member of a self-regulatory organization (SRO).
A registered securities exchange is exempt from state blue sky regulations. However, an ATS must comply with blue sky regulations in order for residents of those states to trade securities on their ATS platform.
Which approach is best for your crypto enterprise? The answer will depend on your business model, short and long-term business goals, product features, technical functionality as well as the physical location of your business and your customers. Some companies benefit by becoming a fully registered entity, and some companies are better suited to the ATS approach with BD registration and SRO membership.
Regulatory Penalties Can Be Harsh
A few months ago we reported on Munchee, a foodie mobile app that got into hot water when they issued an ICO for their customer rewards token. Their story caught our attention, because they were bankrupted by an SEC enforcement action, becoming one of the first casualties of the Cyber Unit at the SEC.
The Munchee developers believed their customer rewards token was a utility token, not a security token, as defined by the Howey Test for investment contracts. They were careful to include disclosure information with phrases like, “…does not constitute the offering of a security.”
However, the SEC disagreed with their position, and their enforcement penalties put Munchee out of business.
Crypto is standing center stage in the SEC spotlight. When we consider recent enforcement actions as well as the tenor and tone of new public statements, we believe there’s no better time to make regulatory compliance a top priority for any company doing business in the crypto category.
Get In Front of Crypto Enforcement Actions
Please don’t hesitate to reach out for a regulatory compliance review for your ICO, cryptocurrency, or crypto exchange platform.
InnReg has a proven track record in the crypto category. We help our clients understand SEC regulatory requirements, and then we develop a customized compliance program that meets those requirements based on their unique business model.