On September 15, 2020 the U.S. Securities and Exchange Commission (“SEC” or “Commission”) issued an order denying the SEC’s Division of Enforcement’s (the “Division”) motion to expedite enforcement proceedings against American CryptoFed DAO LLC (“CryptoFed”) an issuer of digital assets. CyrptoFed DAO had previously filed a Form 10 registration statement with the SEC seeking to register two classes of digital assets, the Ducat and Locke tokens, as equity securities under Section 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”). The SEC instituted a proceeding under Section 12(j) of the Exchange Act alleging that CryptoFed’s Form 10 registration statement was materially deficient. The effect of the 12(j) proceeding was to stay the effectiveness of CryptoFed’s Form 10.

The Division’s motion sought to expedite the 12(j) proceeding after CryptoFed allegedly “announced its intent to begin distributing the Locke tokens … notwithstanding the Commission’s prior order staying the effectiveness of [CryptoFed’s] Form 10.” The Division argued that CryptoFed’s plan to ignore the SEC’s stay order and engage in an unregistered offering of securities made it imperative that the 12(j) proceeding move forward on an expedited basis.

CryptoFed affirmed that it planned to proceed with implementing its business plan by conducting auctions for non-fungible tokens that will later be exchangeable for Locke tokens, unless the Division provides it with a Cease-and-Desist Order including a Howey Test Analysis or other legal justifications to prove that the Locke and Ducat tokens are securities.

In issuing its order the Commission found there was no immediate need to expedite the resolution of the Section 12(j) proceeding, as CryptoFed would be acting “at its peril in beginning to distribute the tokens now regardless of the status of the Section 12(j) proceeding.”

The Commission reasoned that, under the Securities Act of 1933 (the “Securities Act”), an offering of securities is unlawful—and subject to significant civil and criminal penalties—unless it is either registered or exempt from registration. Securities Act Section 5(a) prohibits the sale of securities unless a registration statement is in effect or an exemption applies. Additionally, Securities Act Section 5(c) prohibits offers of sale, which include sales, “while the [filed-but-not-yet-effective] registration statement is the subject of . . . any public proceeding or examination” under Securities Act Section 8.

All of the above Securities Act prohibitions appear to be present and unresolved with respect to the distribution of the Ducat and Locke tokens. For example, the Commission found that CryptoFed had not identified, or purported to identify, any exemption under the Securities Act that applies to the distribution of its tokens. Further, there is no Securities Act registration statement in effect for the offering. CryptoFed  had filed a Form S-1 registration statement seeking to register transactions involving the Ducat and Locke tokens under the Securities Act;, however the Form S-1 contains a delaying amendment, and therefore is not effective until the Commission declares it effective (which it has not done). In November 2021, the Commission commenced an examination under Securities Act Section 8(e) with respect to the Form S-1, the pendency of which would therefore prohibit the sale of the tokens under Securities Act Section 5(c). In June 2022, CryptoFed filed a Form RW seeking withdrawal of the Form S-1 registration statement acknowledging that the Form S-1 has not been declared effective by the Commission.

The Commission noted that, should CryptoFed  proceed with the distribution of its tokens—irrespective of when and how the Section 12(j) proceeding is resolved—the above facts will be highly relevant to the determination of whether any violation of the Securities Act on its part was willful and deliberate.

Furthermore, the Commission noted that CryptoFed’s potential liability under the Securities Act for an unregistered, non-exempt offering of the tokens is independent of the effectiveness of CryptoFed’s Exchange Act registration statement with respect to the tokens (i.e., the Form 10). In its order the Commission reiterated that registration of securities offerings under the Securities Act is distinct from registration of classes of securities under the Exchange Act and registration under one statute does not excuse registration under the other when it is otherwise required. So even if the Form 10 was effective, any securities offering would still need to be pursuant to a Securities Act registration statement or pursuant to a Securities Act exemption from registration.

The Commission’s order clearly warns CryptoFed that if it proceeds with its distribution plan it will face additional potential liability for violations of the Securities Act regardless of the pendency of the 12(j) proceeding. Accordingly, in denying the Division’s motion the Commission left CryptoFed with a Hobson’s choice – resolve its registration issues under both the Securities Act and Exchange Act with regards to the Ducat and Locke tokens prior to distributing them or proceed to do so at its own peril.

Author

Andrew Zuckerman is a member of Baker McKenzie's Financial Regulation and Enforcement Practice Group, which provides our clients with a full range of regulatory advice and enforcement counseling from both a US and global perspective.