SEC Commissioner proposes 3-Year safe harbor period for crypto token sales
Updated: Feb 11, 2020
Hester M. Peirce, two-year official at the U.S. Securities and Exchange Commission, also known as “CryptoMom”, has formally proposed a safe harbor for token projects. This would provide start-up projects with breathing room in order develop their networks and communities prior to having to adhere to the US regulatory regime.
Peirce’s proposal was unveiled during a speech at the International Blockchain Congress in Chicago, where she proposed that crypto start-ups should have a three-year grace period from their first token sale to achieve a level of decentralization that is sufficient to pass through the agency’s securities evaluations. This would include the Howey Test, the famous U.S. Supreme Court assessment standard of what constitutes an "investment contract" and hence attracts regulatory compliance obligations.
Peirce said in her proposal:
The analysis of whether a token is offered or sold as a security is not static and does not strictly inhere to the digital asset.
In other words, Peirce is reinforcing that while some tokens may appear to have the qualities of a security at launch, they may mature to the point where they no longer appear to be a security under US law.
The application of the federal securities laws to these transactions frustrates the network’s ability to achieve maturity and prevents the transformation of the token sold as a security to a non-security token functioning on the network
Peirce has previously floated the idea of a safe harbor in the past, but this attempt at a proposal seems to be her first formal attempt to make this a reality.
If adopted by the majority of the SEC’s other commissioners, it would create a strict set of requirements for crypto projects to raise funds through a token sale, including requiring personal disclosures, code disclosures, public notices and a number of other factors.
Peirce also said:
The safe harbor is also designed to protect token purchasers by requiring disclosures tailored to the needs of the purchasers and preserving the application of the anti-fraud provisions of the federal securities laws.
Specifically, the proposal defines an “initial development team,” which will manage the network’s development over its first three years. The proposal also refers to “network maturity,” which involves an operational network that is “not controlled and is not reasonably likely to be controlled” by a single entity or individual.
The development team would be required to disclose “the names and relevant experience, qualifications, attributes or skills” of each member, as well as how many tokens each member holds and how many they may earn through founders' rewards or similar programs.
The definition of Network Maturity is intended to provide clarity as to when a token transaction should no longer be considered a security transaction but, as always, the analysis will require an evaluation of the particular facts and circumstances.
At the end of the grace period, the initial development team would have to determine whether token transactions constitute securities transactions. The team would then look to create liquidity for the token by securing secondary trading markets (which remain compliant with applicable money transmission and consumer protection laws).
Commissioner Peirce’s proposal would also require a token project’s source code, transaction history (and a description of how an individual can independently search transaction history), token economics, roadmap and a history of past token sales to be disclosed on a free and publicly accessible website.
The safe harbor proposal would also be dependent on development teams acting in good faith, and would not be available to any teams with members who are already disqualified "as a bad actor under the securities laws" due to past actions. Moreover, while the proposal would pre-empt any state securities laws, it would not protect projects from any enforcement actions taken due to fraud or other illicit activities. Peirce reinforced that the safe harbor provisions would not provide immunity from these illegal activities.
Peirce underscored that her goal is simply to focus on new projects in their initial stages of development so as to ensure they can move beyond their first steps in building a network or community.
Australia (and the UK) have not toyed with the idea of a cryptographic token being able to move between being a regulated financial product and not at different points of the life cycle of that token. Rather Australian law is more binary, either something is the issue of a financial product or it is not, and it does not change over time. Despite this difference, the certainty brought by a safe harbour to those who took place in grey activities can only be seen as a reasonable and sensible regulatory response given the delay between technology and regulation which early Initial Coin Offerings faced.