The Secondary Sale Complication
If left unchanged, the Project Crypto release creates a potential compliance nightmare for US crypto exchanges, market makers and "affiliate" token holders
All views are my own and do not represent the views of my firm or my partners. These posts are for informational purposes only and do not constitute legal or financial advice.
The Project Crypto joint interpretive release clarified much. It deserves equal attention for the potential gaps it creates.
Buried in the investment contract analysis is a rule with consequences that cascade well beyond the issuer. The release states, without qualification, that where a non-security crypto asset has not yet separated from the investment contract under which it was originally offered, secondary market transactions in that asset “would constitute securities transactions that must be registered under the Securities Act or conducted pursuant to an available exemption from registration.”
In other words, a digital commodity sold pursuant to an investment contract is a non-security, at the asset-level, but the sale or resale of the digital commodity is a securities transaction. The release draws that distinction carefully and repeatedly. But the distinction creates a potentially monumental diligence obstacle for exchanges, market makers and holders.
The Statutory Backdrop
Section 15(a) of the Exchange Act prohibits any broker or dealer from effecting securities transactions unless registered. Section 6 prohibits operating as a national securities exchange for securities transactions without registration. These provisions are asset characterization-agnostic. What matters is whether the transaction is a securities transaction.
If Token X is a non-security crypto asset that hasn’t separated from its investment contract, secondary trades in Token X are securities transactions. Every exchange facilitating those trades is potentially operating as an unregistered broker (or potentially an unregistered exchange) with respect to those specific transactions. Every market maker providing dual-sided liquidity is potentially operating as an unregistered dealer.
How the Separation Doctrine Impacts Secondaries
The release establishes that a non-security crypto asset becomes subject to an investment contract when an issuer offers it with representations or promises to undertake essential managerial efforts from which purchasers would reasonably expect to profit. That’s the standard Howey analysis applied at the point of original distribution.
The investment contract persists until separation occurs. Two pathways to separation: the issuer fulfills the essential managerial efforts it promised and publicly discloses that completion, or the issuer publicly abandons the effort. Until one of those events occurs, the investment contract remains live. Secondary sales remain securities transactions.
Most token projects have not run the separation analysis. They have not mapped their whitepaper and public communications against a completion framework. They have not publicly disclosed completion of any material promises. For many, the founders and foundations are still posting roadmap updates on X and the BD team is still pitching ecosystem milestones to potential integrators.
Which means a substantial portion of the digital commodity tokens currently trading on Coinbase, Kraken, and every other US exchange are potentially the subject of unregistered securities transactions.
The Exchange’s Dilemma
Compliance-minded exchanges have always conducted diligence on token listings. The release transforms that diligence into something with clearer legal stakes.
The practical compliance question for every exchange listing decision on a token that isn’t BTC, ETH, or one of the other named digital commodities in the release is now: has this token separated from its investment contract?
That requires the exchange to assess: What did the issuer promise? In what channels? Has the issuer fulfilled those promises? Has it publicly disclosed that fulfillment or abandonment? If the answers support separation, secondary sales are not securities transactions, the Section 15(a) and Section 6 concerns don’t arise, and the listing proceeds normally.
If the answers don’t support separation, the exchange is potentially facilitating unregistered securities transactions with every trade.
Two additional complications.
First, the separation determination isn’t always obvious. Projects with years of diffuse communications, rotating founder Twitter accounts, Discord governance discussions, and informal podcast promises have communication records that no one has ever audited against a completion framework. The exchange may not have the tools or the access to run that analysis reliably.
Second, the exchange faces an ongoing obligation, not a one-time listing gate. A token that has separated from its investment contract can re-enter securities transaction territory if the issuer begins making new representations or promises tied to essential managerial efforts. A project that achieved separation by completing its mainnet launch, then begins promising a major protocol upgrade with specific team-driven milestones, potentially creates a new investment contract. The token can cycle back into the problem.
On market makers:
This deserves its own paragraph in the broker-dealer analysis and it’s an important addition. Market makers in crypto operate in two structural categories relevant here.
First, registered broker-dealer market makers. A registered BD can effect securities transactions. If they’re making markets in tokens whose secondary sales are securities transactions, they’re operating within their registration, provided those activities are consistent with their BD registration and applicable exchange rules. The problem is that most registered crypto BDs aren’t currently set up to make markets in tokens that have been characterized as having live investment contracts. Their compliance programs were built around either pure commodities or clearly registered securities, not the middle category the release creates.
Second, and more significant: unregistered market makers. The major crypto market making firms (Wintermute, GSR, Cumberland, others) are not registered broker-dealers in the US. They make markets in crypto assets as principal. The Section 15(a) analysis doesn’t just apply to the exchange platform. It applies to anyone effecting securities transactions as a broker or dealer. A market maker quoting bids and offers in a token whose IC is live, without registration, is potentially effecting unregistered securities transactions on every fill.
The market making loan structure I analyzed in the Token Issuer Guide to Liquidity Management adds another layer. The token loan itself, where an issuer transfers tokens to a market maker to deploy across exchanges, is potentially a transfer of a restricted security if the IC hasn’t terminated. That transfer needs either registration or an exemption. Most loan agreements in the market were structured without that analysis because the underlying token wasn’t considered a security.
The Affiliate Holder’s Problem: Rule 144 Is Largely Unavailable
I covered the Rule 144 framework for token insiders in an earlier piece. The analysis there was built around the assumption that the tokens in question were securities in the first instance. The release’s framework generates the same problem through a different route.
If a secondary sale of a non-security token is a securities transaction because the token hasn’t separated from its investment contract, the selling holder needs either a registration or an exemption. Section 4(a)(1) of the Securities Act exempts transactions by persons who are not issuers, underwriters, or dealers. The threshold question for any non-trivial token holder is whether they qualify as an underwriter under Section 2(a)(11): a person who purchased from an issuer with a view to distribution.
Early investors, advisors, and team members who acquired tokens in Reg D or Reg S offerings are the most exposed. They acquired from the issuer. Whether they acquired with a view to distribution is a facts-and-circumstances inquiry, but the answer isn’t obviously no for most of them. The practical reality is that most early token allocations are acquired with the intent to eventually sell. That intent, if present at acquisition, potentially puts the holder in underwriter territory.
If the holder is potentially an underwriter, Section 4(a)(1) is unavailable. Rule 144 is the next stop.
Rule 144 requires, for affiliate resales: a one-year holding period for non-reporting issuers; the current public availability of specified issuer information; volume limitations; ordinary brokerage conditions; and Form 144 filing for larger sales. For non-affiliates, the one-year holding period alone is required.
The current public information condition is where most token issuers fail. Rule 144(c)(1) requires the issuer to have filed all required Exchange Act reports. Token issuers are generally not Exchange Act reporting companies. Rule 144(c)(2), the non-reporting issuer alternative, requires that specified information about the issuer be publicly available: name, address, state of incorporation, description of business and products, names and titles of all company insiders, balance sheet dated within 16 months, and profit and loss statements for the preceding 12 months.
Most token issuers have not made this information publicly available in the form Rule 144 requires. Projects with pseudonymous founding teams, foreign private issuers without US disclosure programs, and decentralized protocols fail this condition in different ways. Rule 144 is practically unavailable to affiliates for a large fraction of the token market.
The fallback options have their own complications. Section 4(a)(7) permits private resales to accredited investors but carries information disclosure requirements comparable to Rule 144 affiliate resales. Section 4(a)(1½), the judicially developed safe harbor for private resales, lacks certainty and is untested in the token context. Offshore resales under Reg S Rule 904 are available for tokens issued by foreign issuers under Category 1 treatment, but US domestic issuer tokens subject to Category 3 flowback restrictions require carefully structured OTC or brokered transactions, not exchange trades.
The net result: an affiliate holder who acquired tokens in a Reg D offering, in a project that hasn’t separated from its investment contract, and whose tokens are now trading on a US exchange, likely has no clean resale pathway available in the public market.
The CLARITY Solution
The most direct structural fix for the exchange problem is CLARITY. Under the CLARITY Act’s framework, qualifying network tokens trade on CFTC-registered digital commodity exchanges as spot commodity transactions. The securities transaction characterization of secondary sales disappears once a token achieves network token status and its secondary market moves to CFTC jurisdiction. Section 15(a) and Section 6 of the Exchange Act don’t apply to those transactions.
Until CLARITY is enacted, the operative analysis for every significant token listing decision is whether that token’s investment contract has terminated under the release’s separation doctrine.
These gaps reinforce the need for industry comment. If you are interested in comment drafting support, please reach out.