On September 18, 2019, the Securities and Exchange Commission (“SEC”) filed its first civil suit alleging violations of broker-dealer registration requirements in U.S. digital asset markets. In a case filed in the U.S. District Court for the Central District of California, the SEC alleged that Defendants ICOBox and its founder, Nikolay Evdokimov, illegally conducted an unregistered public securities offering for their 2017 initial coin offering (“ICO”), and have operated an unregistered brokerage service facilitating the launch of ICOs in digital asset securities since 2017.
In recent years, the SEC has focused much of its attention on unregistered offerings of digital tokens, issuing guidance on the topic, and initiating both enforcement actions and civil suits against multiple ICO token issuers for offering registration violations. While the SEC’s Division of Trading and Markets has previously issued informal guidance on the application of U.S. broker-dealer regulation to persons facilitating offering and trading in digital asset securities, and the Commission has brought one enforcement action against an unregistered broker-dealer operating in digital asset markets, this case presents the first opportunity for a court to clarify the application of U.S. broker-dealer regulation to the digital asset industry.
Unregistered Offering of Securities
Under Section 5 of the Securities Act of 1933, all public offers and sales of securities must be conducted pursuant to a registration statement on file with the SEC, or under an exemption from registration. Pursuant to the test laid out in SEC v. W.J. Howey, a financial instrument will constitute an “investment contract” and thus a “security” if it evidences (a) an investment of money; (b) in a common enterprise; (c) with a reasonable expectation of profits; (d) from the managerial or entrepreneurial efforts of others.
The SEC first addressed how digital assets could qualify as securities in its 2017 DAO Report. Since issuing this report, the SEC has initiated numerous enforcement actions for conducting unregistered public offers and sales of securities in the form of ICO tokens and issued additional guidance as to how digital assets would constitute securities under the Howey test.
Similar to other cases, the SEC alleged here that Defendants conducted an offering of so-called “ICOS” tokens two weeks after the release of the DAO Report. According to the complaint, Defendants offered and sold ICOS tokens publicly to over 2,000 investors, including U.S. investors, without filing a registration statement or otherwise meeting an exemption from the registration requirement. In particular, ICOBox publicly marketed the offering through its social media, its website, and a white paper before conducting the ICO across five phases in August and September of 2017.
The complaint alleges that Defendants knew about the DAO Report and the registration requirements at the time of the offerings. They represented to potential investors that the DAO Report did not apply because ICOS tokens were either not securities, or otherwise that they had an “exemption” as ICOS tokens “have a utility.”
The SEC argued both that the “exemption” advertised by Defendants does not exist, and that the facts surrounding the ICOS offering satisfy the Howey test because: (a) purchasers would acquire tokens as an investment, providing funds that were pooled to fund a common enterprise, namely ICOBox’s planned ICO facilitation service; (b) ICOS investors had a reasonable expectation of profits either through use of the ICOS tokens to buy into subsequent issuers’ ICOs or via price appreciation in secondary market trading; and (c) purchasers would derive their profits as a direct result of ICOBox’s managerial services. Holders of ICOS tokens could swap their tokens at roughly a 1:4 ratio for tokens to be issued on the ICOBox platform. In certain instances, ICOS tokenholders would allegedly be able to vote on which issuers ICOBox would support with its purportedly top-notch ICO technology, marketing, and legal support personnel. However, Defendants restricted ICOS tokenholders’ ability to engage in such voting to those potential client issuers who were both not paying for ICOBox’s facilitation services, and who had already been “screened by ICOBox experts.”Operation as an Unregistered Broker
The SEC separately brought a novel claim alleging Defendants used the capital from the ICOS offering to illegally develop and operate an unregistered digital asset securities brokerage service. Under the Securities Exchange Act of 1934 (“Exchange Act”), a “broker” is defined as “any person engaged in the business of effecting transactions in securities for the account of others.” Brokerage activity is typically evidenced by persons acting as agents on behalf of others in “key points in the chain of a [securities] distribution.” In such an agency relationship, brokers typically operate “in the business” of assisting issuers seeking to conduct securities offerings and/or investors seeking to buy or sell securities during either an initial offering or on the secondary market—frequently in exchange for transaction-based compensation. Pursuant to Section 15 of the Exchange Act, any person operating as a broker in U.S. securities markets must register with the SEC and obtain membership with, and be regulated by, the Financial Industry Regulatory Authority, or “FINRA,” or operate subject to an exemption from registration.
In this case, the SEC has alleged that Defendants have operated as an unregistered broker since August 2017, by facilitating approximately 35 ICOs of other issuers that raised roughly $650 million from investors. According to the complaint, ICOBox holds itself out to prospective ICO token issuer clients as a “Blockchain Growth Promoter and Business Facilitator,” and has offered to provide substantial marketing, technology, and legal services to connect issuers to potential investors. As examples of Defendants’ brokerage activities, the SEC specifically flagged provision of marketing services to “ensure the soundness of the [issuer’s] business model” and assistance in getting tokens “listed” on token review websites, connecting clients to journalists and bloggers, and promoting clients’ ICOs on ICOBox’s proprietary websites and social media.
Further, the SEC alleged that ICOBox serves as a platform for prospective investors to access clients’ token sales via the Defendants’ own ICOS tokens that could be used to buy into supported offerings at a 75% discount. ICOBox allegedly provides these services to token issuer clients in exchange for both a flat fee based on the scope of services provided, and for transaction-based compensation in the form of a “success fee” of 1.5-6% of the funds raised in the offering.
To demonstrate that ICOBox provided such services to effect transactions in securities as defined by Howey, the SEC also explicitly highlighted the services ICOBox provided for one specific client—the issuers of the Paragon Coin ICO tokens. In a previously issued November 2018 settlement order, the Commission brought an enforcement action against Paragon Coin for conducting an illegal, unregistered securities offering. In addition, the Commission pointed to an ICOBox January 2019 press release, where the firm stated it planned to provide these services for “security token offerings” and to become “the Leader of the Emerging Security Token Market.”Takeaways
The Commission has previously issued guidance on the application of broker-dealer registration requirements to digital asset securities issuance and transactions, and conducted an enforcement action against an unregistered broker-dealer serving as a self-described “ICO Superstore” in September 2018. As the SEC’s first case filed in court against a person operating an illegal, unregistered securities broker-dealer in digital asset markets, however, this is the first time a court may have the opportunity to determine the proper application of the Exchange Act’s “broker” definition to digital asset activities. In the months to come, it will be worth observing how the court applies the definition of a “broker” to activities engaged in within digital asset securities markets, the extent to which this application aligns with the SEC’s existing guidance, and any added clarity the case may bring.
Additionally, this case indicates the SEC’s intent to bring charges against actors connected to previous SEC digital asset enforcement actions. While ICOBox allegedly provided similar brokerage services to 34 other ICO token issuers, the SEC specifically highlighted its work for Paragon Coin. In doing so, the SEC may be signaling that, where possible, it will expand its focus beyond initially identified violations to address compliance issues in the broader digital asset market infrastructure. Thus, firms whose activities were connected to prior SEC enforcement actions against other actors in digital asset markets should consider the risk of subsequent action against themselves and whether it would be beneficial to proactively engage with the SEC. The Commission has already demonstrated its willingness to take a more lenient enforcement approach against self-reporting violators in ICO token markets. By proactively coming forward, such related actors may mitigate the risk of harsher enforcement penalties from the SEC in the future.
 15 USC § 77e.
 328 U.S. 293 (1946); see also 15 U.S.C. §77b(a)(1) defining a “security” to include an “investment contract.”
 Complaint at 8.
 SEC v. ICOBox and Nikolay Evdokimov, No. 19-CV-08066 at 15 (C.D. Cal. Filed Sept. 18, 2019) (hereinafter the “Complaint”).
 Complaint at 11.
 See Complaint at 13.
 15 USC § 78c(a)(4).
 See e.g., Mass. Fin. Servs., Inc. v. Sec. Inv’t Prot. Corp., 411 F. Sup. 411, 415 (D. Mass.) aff’d. 545 F.2d 754 (1st Cir. 1976), cert. denied, 431 U.S. 904 (1977); SEC v. Nat’l Exec. Planners, Ltd., 503 F. Supp. 1066, 1073 (M.D.N.C. 1980).
 See e.g., SEC v. Martino, 255 F. Supp. 2d 268, 283 (S.D.N.Y. 2003); SEC v. Margolin, No. 92 CIV. 6307 (PKL), 1992 WL 279735, at *5 (S.D.N.Y. Sept. 30, 1992).
 15 U.S.C. § 78o(a)(1), (a)(8).
 Complaint at 17.
 See Complaint at 18.
 Complaint at 19.
 Complaint at 21.