The Securities and Exchange Commission (SEC) filed a complaint against a crypto market maker on October 10, 2024, alleging that the company was operating as an unregistered securities broker-dealer in violation of Section 15(a). ) of the Securities Exchange Act of 1934 (Exchange Act) by acting as a market maker in crypto-asset securities.
Market Maker Operations and Alleged Violations
The complaint highlights several aspects of the market maker’s operations that, according to the SEC, constitute the act of a “broker,” defined in Section 3(a)(5) of the Exchange Act to mean “any person engaged in buying and selling activity. sell securities…for its own account through a broker or otherwise,” excluding any person who buys or sells securities, “but not in the course of a regular business.” As we noted in a previous Morgan Lewis report, the consequences of being a broker are significant, including the requirement to register with the SEC and become a member of a self-regulatory organization (SRO), such as the Financial Industry Regulatory Authority (FINRA). ).
The complaint alleges, among other things, the following:
- Own account trading: The market maker engaged in numerous proprietary transactions, including buying and selling cryptoassets for its own account through its online platform and third-party platforms.
- Liquidity provision: The market maker has presented itself as one of the leading liquidity providers in the crypto-asset market. They provided price quotes to counterparties and facilitated transactions on a primary basis.
- Public performance: The market maker has actively promoted its cryptoasset trading business through industry conferences, media appearances, and by allowing other crypto companies to display its logo.
The SEC argues that these activities, combined with the market maker’s management of at least $2 billion in cryptoassets offered and sold as securities, demonstrate its role as a broker-dealer.
Crypto assets identified as securities
The SEC specifically identified five cryptoassets traded by the market maker that it believed were offered and sold as investment contracts, and therefore as securities:
- Polygon (formerly MATIC, now POL)
- Solana (SOL)
- Cosmos (ATOM)
- Algorande (ALGO)
- Filecoin (FIL)
The SEC cites public statements by the issuers and sponsors of these assets, as well as their economic structures, as evidence that investors reasonably expected profits based on the efforts of others.
Importance and implications
This case is emblematic of increased regulatory scrutiny over companies that actively trade cryptoassets. The SEC’s emphasis on proprietary trading, liquidity provision, and public marketing suggests that companies engaging in similar activities should carefully evaluate their compliance with the securities laws.
The SEC has historically recognized a “dealer” exception to the definition of broker-dealer, exempting persons or entities buying and selling securities for their own account, but not in the course of a regular business. However, the scope of this exception is arguably less clear in the context of cryptoassets, and the SEC’s February 6, 2024 adoption of new Rules 3a5-4 and 3a44-2 under the Exchange Act, defining specifically what it means to be engaged in trading in securities and public securities, has sown further confusion about the scope of the exception more generally.
Businesses with frequent or large-scale trading activities could consider whether they might also be eligible to qualify as a broker-dealer or otherwise qualify for the dealer exception.
Key considerations for crypto market participants
- Regularity and scale of exchanges: Firms that engage in frequent, large-scale trading of cryptoassets that may have the effect of providing liquidity to the market should evaluate their activities against the broker definition and the new rules.
- Marketing and public representation: Presenting yourself as a market maker or liquidity provider could attract the attention of regulatory authorities.
- Reference price: Continuous quotation of buying and selling prices of cryptoassets may indicate broker activity.
This case highlights the SEC’s ongoing efforts to regulate the crypto market and bring it under existing securities laws. It also reflects the SEC’s continued focus on the activity of unregistered broker-dealers, following a series of enforcement actions, litigation and other civil complaints (e.g., related to so-called toxic lenders, credit line and others).
Market participants should closely monitor developments in this area and seek legal advice to ensure compliance.
(See source.)
