As the regulatory environment around cryptocurrency and digital assets continues to evolve, the SEC’s scrutiny over digital assets has intensified. Companies in this space have become the subject of numerous recent enforcement actions signaling the need for businesses to ensure compliance with securities law for both their business and those businesses they’re working closely with. Below are some of the most significant regulatory developments and compliance considerations that businesses in the digital asset space should be aware of.
1. Classification
One of the most pressing and recurring challenges in the digital asset sector is determining what qualifies as a security. Under the “Howey Test,” securities are an investment of money through a common enterprise with an expectation of profits derived from the efforts of others. This definition is central to enforcement actions such as SEC versus Ripple Labs where the court determined that sales of XRP tokens to institutional purchasers were unregistered securities offerings. However, the court also held that sales to retail investors on secondary exchanges did not constitute securities transactions. This mixed ruling suggests that companies must carefully consider the structure of their offerings to avoid violating securities laws and opens up debate on how securities laws apply.
2. Heightened Focus on Investor Protection and Fraud Prevention
The SEC has intensified its focus on protecting investors from fraud and market manipulation within the cryptocurrency sector. Matters at the forefront of this issue include pump-and-dump schemes, unregistered coin offerings, and other deceptive practices. Additionally, regulatory bodies are rewarding whistleblowers who provide significant information, incentivizing reporting of wrongdoing. In August, the CFTC announced an award of $1 million to a whistleblower who provided the CFTC with information to bring an enforcement action connected to digital asset markets. This increase in whistleblower awards underlines the regulators’ commitment to identifying fraud and enhancing transparency in crypto.
3. Digital Asset Exchanges and the Importance of Registration
The SEC has also dedicated more attention to ensuring cryptocurrency platforms meet registration requirements. Platforms that facilitate trading in securities must register as exchanges or alternative trading systems. In September, the SEC reached a $1.5 million settlement with eToro to charge that it operated an unregistered broker and unregistered clearing agency in connection with its trading platform that facilitates transactions with certain crypto assets as securities. Similarly, Kraken was charged last year for operating its crypto trading platform as an unregistered securities exchange, broker, dealer, and clearing agency. These cases highlight increasing regulatory scrutiny and the need for companies to ensure internal compliance as well as compliance with the exchanges they deal with.
4. New Actions Related to the Custody Rule
The SEC recently pursued its first enforcement action related to the custody rule, which protects client assets held by registered investment advisors. In September, the SEC filed charges against a former registered investment advisor. The charges stemmed from the advisor’s failure to comply with custodial requirements for certain cryptocurrency assets held by their private fund client. Specifically, the advisor did not ensure that these assets, which were offered and sold as securities, were maintained with a qualified custodian as required by regulations.
In light of increased enforcement and the SEC’s expanded focus on crypto markets, companies involved in digital assets should proactively assess their compliance measures. However, as a result of the 2024 U.S. election, the Trump administration is expected to scale back some of the scrutiny concerning digital assets and establish a clearer regulatory framework. As the regulatory environment continues to evolve, industry participants should monitor regulatory developments and prepare to be responsive.