The SEC recently announced a settlement in connection with the operation of unregistered virtual-currency-based stock exchanges. The settlement is instructive as to how the SEC will evaluate crypto-currency trading platforms (spoiler alert: the same way they evaluate all other trading platforms) and also as to the benefits of full cooperation with the SEC in the context of an investigation.

For a little over a year, two online, crypto-currency-based stock exchanges were operated by BTC Trading, Corp. (BTC Trading), a company formed and operated out of Belize and 100% owned by a California man, Ethan Burnside. The two exchanges were LTC-Global Virtual Stock Exchange (which utilized the virtial crypto-currency Litecoin) and BTC Virtual Stock Exchange (which utilized the virtual crypto-currency Bitcoin). Issuers could sign up to offer their securities for sale to registered users of these two exchanges, and anyone with an email address could become a registered user and purchase securities. In addition, users could purchase securities in the exchanges themselves. In all, 121 issuers used these two platforms to sell shares. None of these securities or offerings were ever registered with the SEC.

Aside from operating the exchanges, Burnside and BTC Global also solicited purchasers and brokered sales via the exchanges. Burnside also purported to sell securities of LTC-Mining, a Litecoin mining enterprise operated by Burnside but unincorporated as an entity. Burnside sold what he called “LTC Mining bonds,” which entitled the bondholders to a share in profits earned by LTC-Mining from mining Litecoins.

It almost goes without saying that these activities amounted to numerous and blatant violations of the securities laws. Section 5 of the Securities Act prohibits the offer and sale of securities in interstate commerce unless the securities are registered or exempt. A securities exchange must be registered pursuant to Section 6 of the Exchange Act in order to lawfully effect or report transactions in securities, and a failure to comply is a violation of Section 5 of the Exchange Act. Other than the fact that they operated using crypto-currencies, LTC-Global Virtual Stock Exchange and BTC Virtual Stock Exchange were textbook examples of securities exchanges. Burnside and BTC Global also violated Section 15(a) of the Exchange Act by engaging in the business of effecting transactions in securities without being registered as broker-dealers or exempt from registration.

But despite these violations, Burnside emerges from the SEC settlement relatively unscathed. He is required to disgorge profits, with interest, amounting to approximately $60,000; is barred from participating in the securities industry for two years (Burnside’s livelihood does not appear to be dependent on participation in the securities industry); and must pay a civil penalty of $10,000. The SEC could have easily imposed a lifetime securities industry ban and a much higher civil penalty, but the Commission chose instead to reward Burnside’s role in the SEC investigation.

The SEC described Burnside’s cooperation as follows: “Beginning in September 2013, in immediate response to the Commission staff’s investigation, Burnside began an orderly wind down of both websites. Since September 2013, users have withdrawn funds totaling approximately 200,000 litecoins and 20,000 bitcoins, and in October 2013, both websites ceased operating. Throughout the investigation, Burnside fully cooperated with the Commission staff, providing early and substantial assistance. He made himself available to Commission staff upon request, translated data into accessible formats while producing the raw data to permit independent verification, and he retained financial audit experts to assist in the generation and formatting of reports in order to enable the staff to quickly ascertain the scope and operation of his enterprises. Burnside’s efforts facilitated the staff’s investigation involving an emerging technology.”

As for securities of LTC-Global that Burnside had sold in violation of the Securities Act, Burnside agreed to buy back all of the securities in connection with the SEC investigation. Burnside bought back the securities using Litecoins and Bitcoins and, due to changes in the exchange rates of the virtual currencies, Burnside lost value of approximately $50,000 in the buy-back.

Prior to being contacted by the SEC, Burnside had also repurchased securities of LTC Mining from investors at a loss. In June 2013, Burnside repurchased from investors the LTC Mining bonds he had previously sold them because the venture was not profitable. Burnside repurchased the bonds for about $45,000 more than he had raised by selling the bonds.

For those interested in further background on the SEC’s and FINRA’s views on crypto-currencies and the history of their actions in this area, I recommend this article from CoinDesk.com, which does a good job of providing additional context in the final paragraphs.