On August 9, 2021, the SEC issued a cease-and-desist order against digital asset exchange Poloniex, Inc. for allegedly operating an unregistered exchange in violation of Section 5 of the Exchange Act in connection with its operation of a trading platform that facilitated the buying and selling of digital asset securities.[1]

In the cease-and-desist order, the SEC alleged that Poloniex met the definition of an “exchange” because it “provided the non-discretionary means for trade orders to interact and execute through the combined use of the Poloniex website, an order book, and the Poloniex trading engine.”  The SEC also found, based on internal communications, that Poloniex decided to be “aggressive,” ultimately listing token(s) it had internally determined carried a “medium” risk of being considered securities under the Securities Act of 1933 pursuant to the test set forth by the U.S. Supreme Court in SEC v. W.J. Howey.[2]  However, the SEC did not identify what digital asset(s) it determined were securities nor why, simply stating that Poloniex facilitated trading of “digital assets that were investment contracts and therefore securities.”

Without admitting or denying the SEC’s findings, Poloniex agreed to the entry of the order and a payment of $10,388,309 in disgorgement, prejudgment interest, and a civil penalty.

Takeaways

  • The action highlights the SEC’s heightened focus on and prioritization of regulating digital asset products and emerging industry players that the agency believes may not have abided by certain requirements of the federal securities laws. In its July 2017 DAO Report, the SEC warned that offers and sales of digital assets are subject to federal securities laws and stated that “any entity or person engaging in the activities of an exchange must register as a national securities exchange or operate pursuant to an exemption from such registration” such as the exemption for alternative trading systems.[3]  The cease-and-desist order only covered the period from the publication of the DAO Report until the company was sold in November 2019, even though Poloniex began operating in 2014.
  • The SEC provided no guidance, however, about which digital assets it deemed to be securities, suggesting that it will continue to take a cautious approach to classifying particular digital assets. At the same time, SEC Commissioner Hester M. Peirce reiterated her ongoing concern over lack of legal clarity for crypto exchanges.[4]  She pointed out in her dissent that, during the time period in question, it would have been inefficient for Poloniex to register as an exchange (or a broker-dealer to operate an alternative trading system).[5]  She argued that the SEC was “moving very cautiously with respect to regulated entities’ engagement with crypto assets,” and that registration would not have been possible as a practical matter because Poloniex would have been forced to wait for an extended period of time for any potential approval.
  • The action is an indication that other actions are likely to follow, as other crypto exchanges may have undertaken similar activity to Poloniex in light of the regulatory uncertainty surrounding digital assets that has prevailed in the past several years. This is consistent with SEC Chair Gary Gensler’s recent remarks and letter to Senator Elizabeth Warren stating that the SEC will actively assert jurisdiction over entities that engage in the unregistered sale of digital asset securities, particularly crypto exchanges and decentralized finance (DeFi) protocols.[6]  For example, the SEC recently issued a cease-and-desist order against Blockchain Credit Partners and its founders for unregistered sales of securities in violation of Section 5 of the Securities Act through its DeFi Money Market platform.[7]  The SEC found that the respondents misled investors concerning the platform’s operations and profitability in violation of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder.

We will continue to follow regulatory developments as the SEC seeks to establish the boundaries of permissible digital asset trading and lending activity.


[1] Press Release, SEC Charges Poloniex for Operating Unregistered Digital Asset Exchange (Aug. 9, 2021).

[2] See SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (finding that an investment contract exists when there is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.).

[3] See Report of Investigation Pursuant to  Section 21(a) of the Securities Exchange Act of 1934: The DAO (Exchange Act Rel. No. 81207) (Jul. 25, 2017).

[4] Commissioner Peirce has previously dissented to other enforcement actions related to digital assets.  See, e.g., our analysis of Unikrn, Inc..

[5] See Public Statement by Commissioner Hester M. Peirce, In the Matter of Poloniex, LLC (Aug. 9, 2021).

[6] See Gary Gensler, Remarks Before the Aspen Security Forum (Aug. 3, 2021); See, also, Letter from Chair Gary Gensler to Senator Elizabeth Warren (Aug. 5, 2021).

[7] Blockchain Credit Partners used smart contracts on the Ethereum blockchain and DeFi technology to sell two types of digital asset tokens: (i) “mTokens” that offered 6.25% in interest and (ii) “DMG governance tokens” that offered voting rights and profit-sharing.  The profits were to come from non-digital assets, such as car loans, which Blockchain Credit Partners would obtain using the token purchaser funds.  According to the cease-and-desist order, the income from the assets was insufficient to cover appreciation of investors’ principal due to the significant price volatility of the digital assets used to purchase the tokens.  The respondents falsely claimed that the platform purchased the loans while using personal funds and funds from their separate company that actually owned the loans to cover mToken redemptions.  The SEC determined that the tokens were either (i) notes or (ii) investment contracts and therefore securities subject to registration. See Press Release, SEC Charges Decentralized Finance Lender and Top Executives for Raising $30 Million Through Fraudulent Offerings (Aug. 6, 2021).