DAO Tokens, Section 5 Obligations and Regulation ATS
Posted by Laura Anthony, Esq. on October 10, 2017
DAO Tokens, Section 5 Obligations and Regulation ATS- On July 25, 2017, the SEC issued its Report on an investigation into an ICO and related activities by the DAO, an unincorporated entity, Slock.it UG (“Slock.it”), a German corporation, and various principals and participants. Previously in this Lawcast series I went through the parameters of the Howey Test to determine if a particular investment contract is a “security” under the federal securities laws and applied the analysis to the DAO and its ICO offering.
Upon concluding that the DAO Tokens were securities, the SEC also concluded that the DAO needed to register their issuance, or satisfy a registration exemption, regardless of whether the DAO was incorporated or an unincorporated organization. Issuers, like securities, are broadly defined to include any sponsor or organization that is primarily responsible for the success or failure of the venture. Participants in an offering are also subject to Section 5 obligations and liability. Accordingly, this included the Slock.it founders and principals.
The secondary trading platforms also required registration, or the availability of an exemption, under the federal securities laws. Section 5 of the Exchange Act makes it unlawful for any broker, dealer or exchange to directly or indirectly affect any transaction in a security or report such transaction unless the exchange is registered as a national exchange or exempted from such registration. Section 3(a)(1) of the Exchange Act defines an “exchange” as “any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood …”
The functions of a stock exchange generally include: (i) bringing together orders for securities of multiple buyers and sellers; and (ii) using established, non-discretionary methods under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of the trade. A frequent exemption to the definition of an exchange is an Alternative Trading System (ATS) that complies with Regulation ATS. Regulation ATS requires, among others, registration as a broker-dealer. The OTC Markets is an ATS, as is t0 Technologies. The platforms that traded the DAO Tokens fit within the definition of an exchange and did not satisfy any available registration exemptions.