Hester Peirce, who is a Commissioner of the U.S. Securities and Exchange Commission (SEC) and affectionately referred to as Crypto Mom, formally proposed, during a speech on February 6, a safe harbor from certain U.S. securities laws aimed at cryptotoken network developers. The proposed safe harbor would provide network developers with a three-year exemption from certain aspects of U.S. securities laws with respect to token transactions so long as certain conditions are met. Ms. Peirce posits that the safe harbor will facilitate development of functional tokens and evolution toward network decentralization through reduced requirements under U.S. securities laws and, consequently, alleviating fears of enforcement actions. The safe harbor harkens back to prior statements and letters from SEC representatives indicating that it is possible for a token to move outside the purview of U.S. securities laws if the network becomes sufficiently functional and decentralized.
The Current State of Play:
U.S. securities laws require that, before offering securities for sale, an issuer must register with the SEC or rely on an exemption from registration. Generally, the SEC has analyzed tokens under the definition of an investment contract set forth in longstanding precedential case, SEC v. Howey. An investment contract is a type of security under the U.S. securities laws. Thus, a token that constitutes an investment contract under the Howey case requires registration or an exemption before its sale.
As Ms. Pierce said, to date, there has not been any registered token offerings in the U.S., though several issuers of tokens have opted for conducting exempt offerings pursuant to Regulation A (so-called “mini-IPOs”). Token sellers have predominately relied on what is referred to as a Reg. D exemption, which forgoes the registration requirement as long as the sale is limited to a private placement (i.e., not publicly offered) for accredited investors. Following the initial token sale—whether it be by registration or exemption—subsequent token transactions and involved parties are subject to additional securities rules and registrations. For example, tokens sold under a Reg. D exemption are subject to transfer restrictions, thereby limiting secondary trading and adoption of the network.
These securities laws are intended to protect investors but some in the crypto industry contend that the rules stymie network development.
The Proposed Safe Harbor:
Provided that certain requirements are met, the proposed safe harbor grants network developers a three-year exemption from (1) the Securities Act of 1933, other than the antifraud provisions, with respect to the offer and sale of tokens (2) registration for the tokens under the Securities Exchange Act of 1934 (the 1934 Act), and (3) the definitions of “exchange,” “broker,” and “dealer” under the 1934 Act with respect to persons engaged in certain token transactions.
After complying with U.S. securities law during the initial sale of the token (e.g., offering the tokens under one of the exemptions from registration such as a Reg. D. offering), network developers may thereafter qualify for the three-year grace period if they demonstrate that they are working toward decentralization. More specifically, the proposed safe habor requires that network developers do all of the following:
- “[I]ntend for the network on which the token functions to reach network maturity—defined as either decentralization or token functionality—within three years of the date of the first token sale and undertake good faith and reasonable efforts to achieve that goal.”
- “[D]isclose key information on a freely accessible public website.”
- Offer and sell the token “for the purpose of facilitating access to, participation on, or the development of the network.”
- “[U]ndertake good faith and reasonable efforts to create liquidity for users.”
- “File a notice of reliance.”
Ms. Peirce explained that these requirements serve as proxies for the considerations raised in the Howey case. Further, she reasons that three years affords the network ample time to transition into being sufficiently functional and decentralized such that the U.S. securities law would no longer apply to the token transactions. In other words, the proposal balances the investor protections afforded by U.S. securities laws with the regulatory flexibility to foster innovation.
The full transcript of Ms. Peirce’s speech, including elaboration on the five requirements, and text of the proposed Safe Habor is available here. Importantly, Ms. Peirce notes that notwithstanding an exemption from U.S. securities laws, any network developer must still comply with all other applicable federal and state laws, as well as regulations relating to money transmission, anti-money laundering, and consumer protection.