On January 10, 2022, the Securities and Exchange Commission (“SEC” or the “Commission”) announced it settled charges in In re tZERO ATS, LLC, No. 93938 (SEC Order Jan. 10, 2022) (“Order”).  The Order details how the SEC fined blockchain-based trading platform tZERO ATS, LLC (“tZERO”), an alternative trading systems (“ATS”), for alleged violations of Regulation ATS, which requires certain disclosures to the Commission.

An ATS is a trading system that meets the definition of “exchange” under federal securities laws but is not required to register as a national securities exchange if the ATS operates under an exemption provided under regulations under the Securities Exchange Act of 1934 (“Exchange Act”).  As stated in the Order, tZERO is an ATS that offers both “digitally enhanced securities” recorded on a blockchain and trading and settlement services for unique investments that may not be available through traditional brokerages.

According to the SEC, the regulations require an ATS to disclose various aspects of its operations to the Commission, such as its order entry procedures, the manner in which it displays orders or quotes, and the roles and responsibilities of any entity involved in the operations of the ATS, as well as to file amendments on Form ATS within certain time periods prior to implementing a material change to the operation of the ATS or to correct any inaccuracies in a prior filing.  The SEC alleged that tZERO did not timely disclose certain information to the SEC in its Form ATS concerning its subscriber’s display of order book information for certain digitally enhanced securities.  Specifically, the Commission alleged that tZERO failed to disclose that tZERO was acquiring the assets of an entity that tZERO had been sharing order information with regarding digitally enhanced securities.  The SEC considered this to be a material change requiring tZERO to file an amendment to its Form ATS.  The Commission also claimed that tZERO failed to comply with its Fair Access of Regulation ATS by not establishing written standards for granting access to trading on its system with respect to digitally enhanced securities that exceeded certain daily trading volume on the ATS.

In response to the SEC initiating public administrative and cease-and-desist proceedings against tZERO, tZERO submitted an Offer of Settlement, which the SEC accepted.  tZERO agreed to comply with Regulation ATS in the future and pay a civil money penalty in the amount of $800,000.

The SEC emphasized that it is important for entities to provide “accurate, current, and complete disclosures on Form ATS.”  The information on how the ATS displays orders and trading interest is important for buyers and sellers because it gives insight into liquidity in the ATS and execution of a participant’s orders.  The disclosure requirements also enable the Commission to determine whether the ATS is complying with federal securities laws.

While other recent SEC enforcement actions against blockchain-based platforms and entities involved allegations of fraud, the tZERO Order focused on apparent failures in required disclosures and filings.  The Order does not delve into substantive issues about the agency’s stance on “digitally enhanced securities” or how they could be regulated differently in the future. As such, new digital finance platforms that fall under the SEC’s jurisdiction will, for now, have to follow applicable federal securities laws and regulations as a debate brews in Washington on how the federal government should oversee the burgeoning cryptocurrency industry.