On August 9, 2021, the U.S. Securities and Exchange Commission (the "SEC") issued an order (the "Order") settling an administrative proceeding in which it found that Poloniex, LLC, operated an unregistered national securities exchange in violation of Section 5 of the Securities Exchange Act of 1934 (the "Exchange Act"). According to the Order, Poloniex operated a digital asset trading platform (the "Platform") starting in 2014 that was an exchange under federal securities laws because, based on established, non-discretionary methods, it "matched the orders of multiple buyers and sellers in digital assets, including digital assets that were investment contracts under SEC v. W.J. Howey Co., 328 U.S. 293 (1946), and therefore securities." Poloniex did not register the Platform as a national securities exchange under the Exchange Act or operate under an exemption from such registration.
Users of the Platform ("Users") established accounts with Poloniex and entered orders to trade digital assets listed on the Platform through a web-based interface or a mobile app using one of three order types: market order, limit order, or stop-limit order. The Platform displayed the top of book (the top firm bids and offers) for digital assets by symbol, price, and size. The Platform matched orders in its order book on a price-time priority basis and charged trading fees based on a User's volume and a maker-taker fee schedule.
The SEC found that Poloniex allowed Users to trade digital asset securities on the Platform. Poloniex had a stated policy prohibiting the listing and trading of digital asset securities on its Platform, a policy it reiterated in 2017 after the issuance of the so-called DAO Report. According to the SEC, however, Poloniex stated internally that it wanted to be aggressive in making new digital assets available for trading, including digital assets that might be considered securities under the Howey test. A third party acquired Poloniex in 2018 and updated Poloniex's process for listing digital assets. Poloniex nevertheless determined that it would allow Users to trade digital assets on the Platform that were at "medium risk" of being considered securities under Howey. Poloniex delisted a number of digital assets it determined might have been securities from trading on the Platform, but the SEC concluded that certain of the digital assets that Poloniex allowed to continue trading on the Platform were digital asset securities.
The SEC determined that the Platform met the definition of "exchange" under Section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder. According to the SEC, the Platform operated as a marketplace or facility for bringing together purchasers and sellers of securities within the meaning of Section 3(a)(1) and Rule 3b-16. Moreover, orders sent to the Platform by multiple buyers and sellers, i.e., the Users, interacted with each other in accordance with the Platform's established, non-discretionary methods for matching orders. In addition to ordering Poloniex to cease and desist from violating Section 5 of the Exchange Act, the SEC ordered Poloniex to pay disgorgement of approximately $8.5 million and a civil penalty of $1.5 million.
The Order raises a number of unanswered questions. It does not identify which digital assets that traded on Poloniex the SEC believes were digital asset securities. Similarly, the Order does not reveal whether the SEC believes that any of the digital assets that traded on Poloniex were not digital asset securities. While the SEC clearly takes issue with the rigor of Poloniex's processes for determining whether a digital asset was a security and should therefore be excluded from trading on the Platform, it is not clear from the Order what review processes are sufficiently rigorous and whether, if a digital asset trading platform applies a rigorous review process, it can avoid an SEC conclusion that it operates an unregistered national securities exchange if the SEC were to determine that, despite the platform's rigorous review process, it admitted a digital asset security for trading.
SEC Commissioner Peirce issued a statement about the Order criticizing the SEC's continued enforcement-centric approach to regulating digital assets. She noted that even had Poloniex sought to register the Platform as an exchange or an alternative trading system, the SEC may not have processed the application because the SEC was moving very cautiously with respect to registered entities engaging with digital assets.
DISCLAIMER: This article was originally published by McGonigle PC prior to their combination with Davis Wright Tremaine LLP. The article is published here with permission.
 https://www.sec.gov/litigation/admin/2021/34-92607.pdf. Section 5 of the Exchange Act (15 U.S.C. 78e) prohibits a national securities exchange from operating unless is it registered under Section 6 of the Exchange Act (15 U.S.C. 78f).
 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO available at https://www.sec.gov/litigation/investreport/34-81207.pdf.