This post continues my recap of where things stand regarding the treatment of tokens, coins, cryptocurrencies, and other digital assets under the federal securities laws. My prior post discussed actions and statements made by the SEC in 2017. This post reviews significant enforcement actions and statements this year prior to the recent Coburn enforcement action.

The Securities and Exchange Commission’s (“SEC”) recent action against a digital trading platform illustrates the continued uncertainty surrounding the treatment of tokens, coins, cryptocurrencies, and other digital assets under the federal securities laws. Senior SEC officials have expressed concern that a significant amount of activity in this industry may not comply with federal securities laws and increasing SEC enforcement activity evinces these concerns. This set of posts offers a recap of the SEC’s previous enforcement actions and statements, providing a reminder to market participants that there is not yet any formal, comprehensive guidance on the reach of federal securities laws in this area. As a result, whether the SEC or a court determines that a particular token, coin, cryptocurrency or digital asset is a security remains a case-by-case, facts and circumstances analysis.

On November 8, the SEC announced an enforcement action charging the founder of a digital “token” trading platform for operating as an unregistered national securities exchange. The SEC has previously brought enforcement actions relating to unregistered broker-dealers and unregistered ICOs, including some of the tokens traded on EtherDelta. Stephanie Avakian, Co-Director of the SEC’s Enforcement Division, commented that “EtherDelta had both the user interface and underlying functionality of an online national securities exchange and was required to register with the SEC or qualify for an exemption.”

In the first post on this topic, we provided a simple answer to a question posed by the Director of the SEC’s Division of Investment Management (the “Division”):

To the extent a fund plans to hold cryptocurrency directly, how would it satisfy the custody requirements of the 1940 Act and relevant rules?”

Our simple answer was to treat cryptocurrencies as “financial assets” under Article 8 of the Uniform Commercial Code. In the second post, we explained how this simple answer may be hard to implement when it comes to trading cryptocurrencies, because their markets require trades to settle in the next block. Thus, rather than a custodian implementing a portfolio manager’s instruction to settle a trade, a portfolio manager trading a cryptocurrency will normally need to have immediate control over the transfer of the cryptocurrency, which is inconsistent with the custody requirements of the Investment Company Act of 1940 (the “1940 Act”).

In this post, we consider three potential solutions to the dilemma faced by an investment company that must hold cryptocurrency in compliance with the custody requirements of the 1940 Act while allowing its adviser to trade the cryptocurrency.

In our previous post, we provided a simple answer to the following question posed by Director Dalia Blass of the SEC’s Division of Investment Management:

To the extent a fund plans to hold cryptocurrency directly, how would it satisfy the custody requirements of the 1940 Act and relevant rules?”

Our simple answer was to treat cryptocurrencies as “financial assets” under Article 8 of the Uniform Commercial Code. But, as Director Blass knows, this is not the end of the questions relating to custody. Her letter included additional questions, such as:

If the fund may take delivery of cryptocurrencies in settlement, what plans would it have in place to provide for the custody of the cryptocurrency?”

This question relates to a core operation of investment companies: trading.

There are no easy answers, but there are simple answers.”—President Reagan

In a January 2018 letter to the ICI and SIFMA, Director Dalia Blass of the SEC’s Division of Investment Management posed the following question, among many others:

To the extent a fund plans to hold cryptocurrency directly, how would it satisfy the custody requirements of the 1940 Act and relevant rules?”

There is a simple answer to this: “Just like our custodian satisfies these requirements with respect to most other financial assets held in our securities account.” But structural differences between cryptocurrencies and more traditional financial assets may make this harder than it sounds.