On Feb. 6, during a speech at the International Blockchain Congress in Chicago, SEC Commissioner Hester M. Peirce unveiled a proposed “safe harbor” that would seek to provide an exemption from the registration requirements of the federal securities laws for blockchain tokens that meet certain criteria. Before discussing the details of her proposed safe harbor, Commissioner Peirce first emphasized that the views expressed in her speech and her proposal, “are my own and do not necessarily represent those of the Securities and Exchange Commission [SEC] or my fellow Commissioners.” Commissioner Peirce also emphasized that her proposal “remains a work in progress.” The proposal has been posted on the SEC’s website along with the text of the speech.
A Regulatory “Catch 22”
The proposal is referred to as the “Token Safe Harbor Proposal” or “Proposed Securities Act Rule 195 – Time-Limited Exemption for Tokens.” In her speech, Commissioner Peirce explained that her proposal seeks to “address the uncertainty of the application of the securities laws to tokens” and “recognizes the need to achieve the investor protection objectives of the securities laws, as well as the need to provide the regulatory flexibility that allows innovation to flourish.” Commissioner Peirce said that the SEC has “created a regulatory Catch 22” with respect to blockchain tokens:
Would-be networks cannot get their tokens out into people’s hands because their tokens are potentially subject to the securities laws. However, would-be networks cannot mature into a functional or decentralized network that is not dependent upon a single person or group to carry out the essential managerial or entrepreneurial efforts unless the tokens are distributed to and freely transferable among potential users, developers, and participants of the network. The securities laws cannot be ignored, but neither can we as securities regulators ignore the conundrum our laws create.
Three-Year Grace Period
Commissioner Peirce’s safe harbor proposal would seek to overcome this conundrum by requiring certain disclosures to protect token purchasers and prevent fraud, while providing “network entrepreneurs sufficient time to build their networks before having to measure themselves against a decentralization or functionality yardstick.” This would be accomplished by providing network developers, termed the “Initial Development Team,” with “a three-year grace period within which they could facilitate participation in and the development of a functional or decentralized network, exempted from the registration provisions of the federal securities laws, so long as the conditions are met.” Those conditions are as follows:
Requirement No. 1 – Intention to Reach Network Maturity
Under the first requirement, the Initial Development Team “must intend for the network on which the token functions to reach network maturity … within three years of the date of the first token sale.” According to the proposal:
Network Maturity is the status of a decentralized or functional network that is achieved when the network is either:
(i) Not controlled and is not reasonably likely to be controlled or unilaterally changed by any single person, entity, or group of persons or entities under common control; or
(ii) Functional, as demonstrated by the ability of holders to use tokens for the transmission and storage of value, to prove control over the tokens, to participate in an application running on the network, or in a manner consistent with the utility of the network.
Requirement No. 2 – Disclosure of Key Information
Under the second requirement, the Initial Development Team must disclose information related to the following “on a freely accessible public website” and provide updates of material changes:
- Source code used by network participants to access the network.
- Transaction history of how to independently access, search and verify transactions on the network.
- Token economics, to include the purpose of the network, protocol and its operation, as well as the launch and supply process; the method for generating and burning tokens; the process for validating transactions; the governance mechanisms for implementing changes to the protocol; and information to enable third parties to create tools to verify token transaction history.
- Plan of development showing how and when the Initial Development Team intends to achieve network maturity.
- Prior token sales, including date of sale, number of tokens sold, restrictions on transferability, amount raised and type of consideration received.
- Initial Development Team and certain token holders, including names, relevant experience and qualifications; number of tokens or rights to tokens owned by each member; description of any transfer restrictions; and any right to be rewarded tokens in the future.
- Trading platforms on which tokens trade.
- Sales of tokens by the Initial Development Team when a member of the team sells 5 percent of his or her tokens, including date(s) of the sale, number of tokens sold and the identity of the seller.
Importantly, Commissioner Peirce’s speech made clear that “the safe harbor would reserve the SEC’s antifraud authority with respect to token sales under the safe harbor.” This would “ensure that the SEC can bring suit against a team that sets out to defraud token purchasers by materially misrepresenting or omitting key information.”
Requirement No. 3 – Sold for Purpose of Accessing Network
According to Commissioner Peirce’s speech, “The third condition is that the token must be offered and sold for the purpose of facilitating access to, participation on, or the development of the network. This condition, along with the definition of token, is meant to clarify that the safe harbor is not appropriate for debt or equity securities masquerading as tokens.”
Requirement No. 4 – Reasonable Efforts to Create Liquidity
The safe harbor’s fourth condition requires the Initial Development Team “to attest that it intends to, and will undertake, good faith and reasonable efforts to create liquidity for users.” In her speech, Commissioner Peirce explained that despite the fact that secondary trading is often “viewed as indicia of a securities offering,” at the same time, in the context of a safe harbor, secondary trading is “necessary both to get tokens into the hands of people that will use them and offer developers and people who provide services on the network a way to exchange their tokens for fiat or crypto currency.” According to Commissioner Peirce’s speech, “To the extent it is aware, the team would disclose any secondary trading platforms on which the token trades.”
Requirement No. 5 – Filing Notice
The final condition would require those relying on the safe harbor to “file a notice of reliance” on EDGAR, the SEC’s online filing system, “within fifteen days of the date of the first token sale in reliance on the safe harbor.” The filing would include an attestation by a member of the Initial Development Team that “all the conditions of the safe harbor are satisfied.”
Prior Sales and Resale Activities
The safe harbor would apply to initial sales and registration of blockchain tokens under the Securities Act of 1933 and the Securities Exchange Act of 1934. Notably, it would also apply to exclude certain secondary market participants from the definitions of “exchange,” “broker” and “dealer” under the Exchange Act. Additionally, the safe harbor would be available for tokens that were previously sold in a registered offering or pursuant to a valid exemption. According to Commissioner Peirce’s speech, “These teams may need the safe harbor in order to permit secondary trading to occur and to distribute their tokens more widely into the hands of potential users.”
Whether the proposal will ever be included in the SEC’s formal rulemaking agenda is yet to be determined. However, according to Commissioner Peirce, she “look[s] forward to additional input, and, if I am able eventually to convince my colleagues to add consideration of such an approach to the SEC rulemaking agenda, many other voices, I hope, will weigh in.” The Commissioner is accepting additional comments to the proposal at CommissionerPeirce@sec.gov.