On September 11, the Securities and Exchange Commission (“SEC”) and the Financial Industry Regulatory Authority (“FINRA”) each separately initiated their first enforcement action for violations of broker-dealer regulatory requirements under U.S. securities laws in digital asset markets. These actions echo all prior agency actions and alerts indicating that where a “security” is involved, both agencies will expect digital asset market participants to fully comply with U.S. securities laws. Additionally, they serve as a serious reminder to all persons acting as “brokers”^[1] or “dealers”^[2] (together, “broker-dealers”) that just because digital asset securities are unconventional securities with unconventional compliance challenges does not mean that either the SEC or FINRA will lower its compliance expectations.

In the first instance, the SEC issued a cease-and-desist order against TokenLot LLC and its operators for acting as unregistered broker-dealers in U.S. securities markets.^[3] The SEC alleged that TokenLot and its operators did so by facilitating sales in tokens from nine initial coin offerings (“ICOs”). In particular it was alleged that they served as “brokers” through marketing and order taking efforts, and by assisting investors and issuers in facilitating ICO token transactions, often in exchange for transaction-based compensation. Meanwhile, the SEC alleged that TokenLot and its operators served as unregistered “dealers” by regularly purchasing tokens from issuers at a discount and either immediately reselling to investors at a profit or holding in inventory to sell later, often based on a pre-arranged agreement with the issuer.

As the SEC has previously reminded market participants operating online platforms, the fact that digital assets are involved instead of conventional stocks or bonds does not eliminate the requirement to register with the SEC where those assets are “securities.”^[4]  Furthermore, while this is the first SEC action concerning broker-dealer registration involving digital assets, the Commission’s Office of Compliance Inspections and Examinations explicitly stated that it intended to prioritize investigating and examining broker-dealer activity in digital asset markets in 2018. Under these circumstances, it is unsurprising that the SEC would issue a cease-and-desist order against such straightforward alleged violations.

Beyond initial registration requirements, FINRA’s enforcement action against Timothy Ayre evidences that persons operating as SEC-registered broker-dealers and FINRA members remain subject to all substantive regulatory requirements, even when engaging in digital asset markets. In its complaint, FINRA alleged that Ayre violated securities laws through material misrepresentations and omissions relating to securities transactions in digital assets backed by shares of Ayre’s own company. As Ayre was simultaneously associated and registered with FINRA member broker-dealers, his actions also allegedly violated multiple of FINRA’s substantive regulations concerning the ongoing conduct and operations of member broker-dealers.^[5] Similar to the TokenLot cease-and-desist, this action is unsurprising, particularly as FINRA also indicated in its 2018 Regulation and Examination Priorities that it would focus on supervising and monitoring FINRA member activity in digital asset markets for potential securities law violations.

These actions are just the latest in a progression of securities law enforcement that began last year with the SEC’s DAO Report and the creation of the Cyber Unit within the Commission’s Enforcement Division. As has been the case in prior enforcement actions initiated by the Cyber Unit, the SEC and FINRA orders against TokenLot and Ayre respectively appear to be allegations of straightforward violations of securities laws through the use of a novel financial instrument.

The message then, as has been the case in all prior digital asset securities law enforcement actions, should be clear: Where securities are involved in a transaction, the U.S. securities laws will be applied. The SEC and FINRA will thus expect persons operating as broker-dealers in these markets to adhere to both their registration requirements and substantive regulatory obligations. While digital asset securities may present unconventional compliance challenges for broker-dealers—for example, those pertaining to customer protection and digital asset control locations, anti-money laundering programs, and margin rules—broker-dealers seeking to engage in these markets should view these enforcement actions as a clear reminder that neither the SEC nor FINRA has any intention of lowering its standards for compliance merely because the securities take the form of digital assets.

[1] Defined in Section 3(a)(4) of the Securities Exchange Act of 1934 (the “Exchange Act”) as “any person engaged in the business of effecting transactions in securities for the account of others.”

[2] Defined in Section 3(a)(5) of the Exchange Act as “any person engaged in the business of buying and selling securities for such person’s own account through a broker or otherwise.”

[3] Under Section 15(a) of the Exchange Act, it is illegal to effect any securities transaction, or induce or attempt to induce the purchase or sale of any security in U.S. markets, unless registered as a broker or a dealer with the SEC or operating subject to an exemption. All SEC-registered broker-dealers must also become members of FINRA, subjecting them to additional regulatory requirements and oversight.

[4] While the March public statement, jointly issued by the SEC’s Divisions of Trading and Markets and Enforcement, points more prominently to national securities exchange registration requirements, it explicitly urged investors to trade in digital asset securities only through SEC-registered entities, including broker-dealers, to obtain the protections of U.S. securities laws and SEC and FINRA oversight.

[5] In particular, the complaint alleged Ayre committed violations of FINRA Rules 2010, 2020, and 3280, which concern high standards of personal honor and just trading provisions, the prohibition on manipulation and fraud in connection with securities transactions, and the failure to provide written notice to his associated FINRA-member disclosing his role in private securities transactions, respectively.