Seyfarth Synopsis: On Thursday, February 6, 2020, SEC Commissioner Hester Peirce proposed rules which, if certain conditions are met, would, for three years, exempt (1) the offer and sale of tokens from most provisions of the 1933 Act, (2) tokens from registration under the 1934 Act, and (3) persons engaged in certain token transactions from the definitions of exchange, broker, and dealer under the 1934 Act. In a speech detailing her proposal, Commissioner Peirce called for the three-year grace period to remedy the “regulatory Catch-22” where networks cannot distribute tokens for fear of violating the securities laws, but at the same time cannot mature into a functional, decentralized network unless they are able to distribute such tokens.
The Proposed Rules
In a speech declaring that “our securities laws stand in the way of innovation,” on February 6, 2020, SEC Commissioner Hester Peirce outlined a set of proposed new rules that, if adopted, would provide a three-year safe harbor from a variety of securities laws to developers trying to build functioning token networks.
In the past, the SEC has warned that it could view the sale of tokens as an illegal sale of securities. In December 2017, SEC Chairman Jay Clayton released a statement saying, “Selling securities generally requires a license, and experience shows that excessive touting in thinly traded and volatile markets can be an indicator of 'scalping,' 'pump and dump' and other manipulations and frauds.” The new proposed rules would provide a three year grace period from the date of the first sale of tokens to most provisions of the Securities Act of 1933, as well as to the Exchange Act’s definitions of “exchange,” “broker,” and “dealer,” and a registration requirement.
In particular, the proposed rules would, inter alia, have the following effects:
- Proposed Securities Act Rule 195: Exemption of any offer, sale, or transaction involving a token from the Securities Act of 1933 if the developer intends for the network to reach certain defined parameters of “Network Maturity” within three years of the date of the first sale of tokens and meets other disclosure, filing, and good faith obligations. The safe harbor would not apply to Securities Act Sections 12(a)(2) (dealing with material misstatements and omissions) and 17 (dealing with fraud).
- Proposed Exchange Act Rule 3a1-2: Exemption from the definition of the term “exchange” to the extent that it involves tokens satisfying the conditions of Rule 195.
- Proposed Exchange Act Rule 3a4-2 and 3a5-4: Exemption from the definitions of “broker” and “dealer” to the extent involving tokens satisfying the conditions of Rule 195.
- Proposed Exchange Act Rule 12h-1(j): Exemption from registration for any token offered and sold in reliance on Rule 195.
The Proposed Safe Harbor Period Would Address a “Regulatory Catch-22”
In her speech, Commissioner Peirce identified that developers are unable to build a decentralized network in which a token has a functional purpose (such as providing access to the network) because they are afraid of violating securities laws—and “[g]iven the SEC’s enforcement activity in this area, these fears are not unfounded.”
With her proposed safe harbor period, Commissioner Peirce hopes to address the “regulatory Catch-22” where developers do not distribute tokens out of fear of securities laws, but then the networks that they have developed cannot mature into a “functional or decentralized network that is not dependent on a single person or group” unless the tokens are “distributed to and freely transferable among potential users, developers, and participants of the network.” The proposed rules would serve to allow developers time to build a decentralized, functional network by distributing tokens without the worry that this distribution would violate securities laws.
As Commissioner Peirce identifies, she is just one of five Commissioners and “cannot write rules unilaterally.” For now, the above is just a proposal and has no legal effect. That said, Commissioner Peirce’s speech and proposal reflect that some in the highest levels of the SEC are paying attention to the conundrums facing securities regulation in the cryptocurrency and blockchain space, and reinforces the need for anyone operating in this space to take special care when navigating the securities laws.