SEC Commissioner Hester Peirce Proposes Safe Harbor For Digital Tokens

United States:

SEC Commissioner Hester Peirce Proposes Safe Harbor For Digital Tokens

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SEC Commissioner Hester M. Peirce proposed establishing a three-year safe harbor
from the securities laws, other than the anti-fraud requirements,
for the sale and trading of digital tokens that satisfy various

Ms. Peirce argued that the application of the so-called
Howey Test” to digital tokens has not worked as
a matter of law, in that applying the Howey analysis to
crypto has become over-inclusive, and has discouraged the
development of worthwhile applications of distributed ledger

Ms. Peirce proposed conditions that a token would be required to
meet in order to benefit from the exemption. These include:

  • the token does not represent a financial interest in an entity
    or any right to receive any ownership interest or the right to
    receive any financial return, whether in the form of a share of
    profits or revenue, or an interest-related return; and

  • at the end of a three-year period, the network on which the
    token is transferred has reached “Network Maturity,”
    meaning that the token or the network on which it is used or traded
    is either:

    • “decentralized,” meaning that it is not controlled
      and is unlikely to be controlled by any single person or by a group
      under common controls; or

    • “functional,” as demonstrated by the ability of token
      holders to use the tokens on the network.

Among the other conditions that the tokens would be required to
meet are provisions intended to exclude “bad actors” from
involvement in the token offering and limited public disclosure
requirements. (All of the conditions to the proposed safe harbor
are set out in the Appendix to Ms. Peirce’s remarks.)

Qualifying token projects and their promoters would be exempt
from Securities Act registration and Securities Exchange Act issuer
registration requirements. In addition, firms acting as
intermediaries with respect to the exempt tokens would not be
required to register as a broker, dealer or exchange. The exemption
would no longer be available if Network Maturity had not been
achieved after three years.

Steven Lofchie

In proposing a safe harbor for digital tokens, Commissioner
Peirce mentions two letters that the SEC staff had issued in which
it took no-action positions as to whether a digital token was a
“security.” The first of these,
Turnkey Jet
, concerned a stablecoin that serves as a substitute
for making payments through a credit card (see this 
related news story

The second no-action letter,
Pocketful of Quarters
, is a genuine attempt by the SEC staff to
grapple with the issue of the difference between a utility token
that is intended to be used (and not purchased as an investment),
and a “security.” As discussed in more detail in a
related news story
, the conditions established by the staff
letter are overly restrictive in certain ways (particularly,
transferability) and set arbitrary limits on the uses that the
developers of the product can make from their sale. In particular,
the prohibition on using revenues from the sale of the product to
further develop the product technology is simply not realistic:
every technology product requires constant and ongoing development;
it is hard to see how a prohibition on using revenue from the
product’s sales to further develop the product is workable.

Commissioner Peirce is quite right to call out the SEC on the
need to develop a legal framework that will allow for the
development of utility tokens (see also
SEC Commission Peirce Criticizes SEC for Law of Clarity on
). The Commissioner is not merely carping here; she
is putting forward a real proposal for comment. Interested persons
should comment. (See instruction how to do so in Footnote
12 to the remarks.)

The proposal will likely need further development and the
imposition of additional conditions. Commissioner Peirce might

  • expanding the definition of “Initial Development
    Team” to include not only those providing “significant
    managerial efforts” but also those who have provided funding
    for the project or will be paid either out of the revenues from the
    sales or by the promoter of the project (one reason for this would
    be to expand the number of persons who would be picked up by the
    “bad actor” disqualification);

  • requiring that the promoter of the project file make
    available at a designated website periodic statements of income and
    expenses and statements of cash flow;

  • requiring that the promoter of the project file make available
    at a designated website all marketing materials that are sent or
    made available to more than a single person; and

  • imposing dollar limits on the amount of tokens that could be
    sold to retail investors, along the lines of what is permitted in
    crowdfunding projects.

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