The U.S. Securities and Exchange Commission (SEC) is warning investors about fantasy stock market games that promise real returns, which could be violating new rules against selling complex derivatives to retail investors, as the regulator brought charges against a company that is alleged to have done just that.

Specifically, the SEC has brought enforcement action against Sand Hill Exchange, a company that is alleged to have sold security-based swaps to retail investors illegally without being properly registered. The firm agreed to settle the charges without admitting or denying the SEC’s findings. It agreed to pay a US$20,000 penalty and to cease and desist from violating the securities laws.

The SEC says its Complex Financial Instruments Unit is watching the retail market for possible violations of the swaps rules, including online competitions that creatively monetize events in schemes that actually constitute security-based swaps transactions.

In addition, the SEC’s Office of Investor Education and Advocacy issued an alert to warn investors about fantasy stock trading and similar websites that may violate federal securities laws.

The alert notes that although investors may think of derivatives and swaps as complex financial instruments only traded by sophisticated institutions, the definitions are in fact much broader and could capture fantasy trading games.

“There are many different ways that virtual games referencing securities could involve a security-based swap,” the SEC’s alert explains. “For example, a website could charge people an entry fee to join an online fantasy stock trading competition in which they would ‘buy’ or ‘sell’ a virtual portfolio of securities and in which they could win a prize. Although any actual situation would need to be analyzed based on the particular facts and circumstances involved, the facts presented in this hypothetical suggest that this website may be offering security-based swaps.”

That’s what the SEC alleged in the Sand Hill Exchange case, in which the firm sold “contracts” referencing a pre-initial public offering company and promising a payout if a liquidity event — such as an initial public offering, merger, or dissolution — occurred. That scheme was shut down before any investors were harmed, the SEC says.

“We were able to act quickly before any losses materialized in this offering that occurred outside the proper regulatory framework,” said Reid Muoio, deputy chief of the SEC enforcement division’s Complex Financial Instruments Unit. “We will continue to scrutinize this space for companies circumventing the law to offer security-based swaps without the safeguards provided to retail investors.”

Indeed, the SEC reports that staff have “recently observed websites offering many different kinds of financial instruments that may raise concerns under the federal securities laws.” Furthermore, the regulator says it’s continuing to investigate websites that may be taking investor money without complying with the federal securities laws.

The SEC alert stresses that even if a website complies with gambling laws, it doesn’t override federal securities laws. Nor can these transactions avoid being captured by securities laws by denominating payouts in Bitcoin or other types of virtual currency.