GUEST BLOG:The SEC Plucks a Chicken by Aegis Frumento Esq

November 29, 2018

More folks should appreciate how hysterical ancient Greek philosophy can be. The whole program consisted of one philosopher making a grand assertion, only to have a younger philosopher chop him off at the knees. This sport went on for generations, until eventually they all got bored and became Stoics. But in the Golden Age of Athens, a debate at the Agora could be restaged today as a roast at the Friars' Club. Remember when Plato described a man as a "featherless biped?" That's when Diogenes the Cynic stood up in the middle of Plato's lecture, held up a plucked chicken, and proclaimed it to be "Plato's man." The crowd loved it. George Costanza and Kramer couldn't have pulled it off any better.

You will think me strange for being reminded of Diogenes and his plucked chicken while reading the SEC's new public statement on "Digital Asset Securities Issuance and Trading." But bear with me. The SEC has spent the whole year trying to come to terms with crypto-currencies and blockchain technology generally. Its new public statement is a useful summing-up, even if it does read a little like the stuff they made us write in middle school about how we spent our summer vacations. 

The report starts off reviewing when a cryptocoin is like a stock (as opposed to, say, like a peso). It's tough to argue that a coin representing an equity interest in some enterprise is not a security. The primary regulatory concern of disclosure applies to both. Whether by stock or coin, the investor who buys into some kind of business is entitled to know all the material facts about that business. So, it makes perfect sense to subject an equity interest represented in a coin to the same disclosure obligations as one represented by a stock certificate. So, yeah, such a coin should of course be regulated as a security.

But then the SEC highlights two recent enforcement actions, one against a coin exchange that didn't register as a securities exchange: In the Matter of Zachary Coburn, Respondent (, 
and the other against a cryptocoin dealer that didn't register as a broker-dealer: In the Matter of Tokenlot, LLC, Lenny Kugel, and Eli L.Lewitt, Respondents  ( They depend on a dubious logical jump, from "a coin is a security" to "a coin exchange is a securities exchange," or "a coin dealer is a broker-dealer." The Securities Laws might well require those results. In fact, I've been advising clients setting up cryptocoin hedge funds and trading platforms to register or get SEC no-action letters since the Spring, because what the SEC did here was totally predictable. And yet, something's still off. The problem is that statutes entrap whatever their definitions include, even if those definitions ignore fundamental differences. Cryptocoin exchanges and dealers fit the statutory definitions governing securities exchanges and broker-dealers in much the same way Diogenes' plucked chicken fit Plato's definition of a man.

When Congress passed the Securities Exchange Act, in the wake of the depression, it was concerned with the rigging of trading and prices by those who operated the Nation's stock markets. It was possible -- it is possible even today -- for trading in stocks to be manipulated by those who run the markets. The original "order book" was kept, on paper, by a specialist on the floor of the exchange. That specialist -- a real person -- could cheat by manipulating the entries on the order book to the advantage of some and the disadvantage of others. That the order books are now maintained electronically only begs the question who controls the algorithms that govern how the order book is maintained. 

And then, behind the order book, is the entire trade reporting and settling machinery that ensures the ownership of a stock is properly transferred from seller to buyer, and of cash from buyer to seller. Each step in this Rube Goldberg contraption can be perverted by some person. The same can be said of dealer-facilitated trades, whether done the old-fashioned way through phone calls or the more modern way through an ATS. Even today, when most stock is held electronically, a stock is still talked about as a thing -- an instrument that can be held in your hand, stored in a safe, and physically delivered to another person. As a thing, stock can be stolen in a myriad of ways, and it's always human beings who do the stealing.

But what if human beings can't pervert the system? Unlike a stock, an equity coin is not a thing at all. One can't hold it, store it or deliver it. A cryptocoin is the output of a computing procedure, what the cognoscenti call an "unspent transaction output." That means simply that the blockchain will only permit the owner of a certain passkey to transfer a certain number of coins to an account controlled by a different passkey. That number, if you know the passkey, is what you "own," and no one can take it from you. Of course, if someone else learns your passkey, you're screwed -- but that's identity theft, not securities fraud. Transferring a cryptocoin using an automated smart contract that is programmed into the blockchain is fundamentally different from buying and selling traditional stock -- because no human being can interfere with its transfer. That's what makes a distributed ledger so secure even though it sits in plain sight on thousands of servers.

Sure, coin exchanges have things that look like order books and price reporting mechanisms, and coin dealers provide a place where people can buy coins. But they aren't the same as stock exchanges or broker-dealers, because beyond their common interest in equity, stocks and cryptocoins work differently. To apply stock exchange logic to a coin exchange is like saying that an 18th-century flintlock and a modern semi-automatic assault rifle are the same because both shoot projectiles. Okay, maybe that's not a good analogy. But you get my point.

Finally, what should we make of the new joint venture between NASDAQ and Microsoft to provide NASDAQ the technology to become a cryptocoin super-exchange? NASDAQ is one of the largest players in the stock market industry. No surprise, it wants to rule the cryptocoin roost too, as it sees traditional stock markets lumbering towards obsolescence. If coin exchanges need to register as stock exchanges, NASDAQ, already so registered, holds an enormous competitive advantage. That's no surprise either, since securities regulation always advantages large established firms against smaller upstarts. Intentionally or not, the SEC is helping NASDAQ monopolize the securities cryptocoin exchange business. Smaller competitors will be, as they usually are, plucked.


Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice

380 Lexington Avenue
New York, NY 10168

Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters.  Mr. Frumento also represents clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents. Those now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises.

Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.

He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of Blog.