The Securities and Exchange Commission (SEC) filed a complaint against a crypto market maker (Market Maker) on October 10, 2024, alleging that the firm operated as an unregistered securities dealer in violation of Section 15(a) of the Securities Exchange Act of 1934 (Exchange Act) by virtue of acting as a market maker in cryptoasset securities.
The Market Maker’s Operations and Alleged Violations
The complaint highlights several aspects of the Market Maker’s operations that the SEC believes constitute acting as a “dealer,” which is defined in Section 3(a)(5) of the Exchange Act to mean “any person engaged in the business of buying and selling securities … for such person’s own account through a broker or otherwise,” excluding any person that buys or sells securities, “but not as a part of a regular business.” As we noted in a previous Morgan Lewis report, the consequences of being a dealer are significant, including the obligation to register with the SEC and become a member of a self-regulatory organization (SRO), such as the Financial Industry Regulatory Authority (FINRA).
In particular, the complaint alleges the following:
- Proprietary Trading: The Market Maker engaged in extensive proprietary trading, including buying and selling cryptoassets for its own account through its online platform and third-party platforms.
- Liquidity Provision: The Market Maker marketed itself as a leading liquidity provider in the cryptoasset market. They provided price quotes to counterparties and facilitated trades on a principal basis.
- Public Representation: The Market Maker actively promoted its cryptoasset trading business through industry conferences, media appearances, and allowing other crypto businesses to display its logo.
The SEC argues that these activities, combined with the Market Maker’s handling of at least $2 billion worth of cryptoassets offered and sold as securities, demonstrate its role as a dealer.
Crypto Assets Identified as Securities
The SEC specifically identified five cryptoassets traded by the Market Maker that it alleges were offered and sold as investment contracts, and therefore securities:
- Polygon (formally MATIC, now POL)
- Solana (SOL)
- Cosmos (ATOM)
- Algorand (ALGO)
- Filecoin (FIL)
The SEC points to public statements by the issuers and promoters of these assets, as well as their economic structures, as evidence that investors reasonably expected profits based on the efforts of others.
Significance and Implications
This case is emblematic of increased regulatory scrutiny on firms actively trading cryptoassets. The SEC's focus on proprietary trading, liquidity provision, and public marketing suggests that firms engaging in similar activities should carefully evaluate their compliance with securities laws.
The SEC has historically recognized a "trader" exception to the dealer definition, exempting individuals or entities buying and selling securities for their own account but not as part of a regular business. However, the scope of this exception is arguably less clear in the context of cryptoassets, and the SEC’s adoption on February 6, 2024 of new Rules 3a5-4 and 3a44-2 under the Exchange Act, further defining what it means to be engaged in the business of dealing in securities and government securities, has sowed fresh confusion about the scope of the exception more generally.
Firms with frequent or large-scale trading activities might explore whether they could similarly be susceptible to characterization as a dealer or might otherwise qualify for the trader exception.
Key Considerations for Crypto Market Participants
- Regularity and Scale of Trading: Firms engaging in frequent and large-scale cryptoasset trading that might have the effect of providing liquidity to the market should assess their activities against the dealer definition and new rules.
- Marketing and Public Representation: Holding oneself out as a market maker or liquidity provider could attract regulatory attention.
- Quoting Prices: Continuously quoting prices for buying and selling cryptoassets may indicate dealer activity.
This case highlights the SEC's ongoing efforts to regulate the crypto market and bring it under the purview of existing securities laws. It also reflects the SEC’s continued focus on unregistered dealer activity, following a trail of enforcement actions, litigated matters, and other civil complaints (e.g., relating to so-called toxic lenders, equity line agreements, and others).
Market participants should closely monitor developments in this area and seek legal counsel to ensure compliance.