Peirce reaffirmed remarks of Division of Corporation Finance Director Bill Hinman likening security tokens to the orange groves in Howey, saying that when they are not sold as investment contracts, tokens are not securities at all.
In regulating token-based securities offerings, the Howey test “seems generally to make sense,” but the SEC must be careful not to apply it too broadly, said Commissioner Hester Peirce. Remarks last June by Division of Corporation Finance Bill Hinman provide a useful framework for analyzing token offerings, said Peirce, and this will be supplemented by supplemental staff guidance and possibly Congressional action. She reminded market participants that there is a standing offer for people to approach the SEC for no-action relief in connection with a particular token or project, and to provide feedback generally.
Enabling, not stifling innovation. Although her remarks at the University of Missouri School of Law focused on cryptocurrency and token offerings, Peirce stressed the need for the SEC to continually look for ways to facilitate capital formation in general.
“As a regulator, when I think about protecting the public, I think not only of protecting investors, but also of ensuring that the capital markets are able to serve the rest of the economy without undue barriers,” said Peirce.
Cautioning against putting a “thumb on the scale” in favor of entrenched market participants, Peirce welcomed Martha Miller to the SEC, who was recently appointed the agency’s first Advocate for Small Business Capital Formation. She listed questions the SEC should consider:
- Can we look for ways for unaccredited investors to pool their resources to invest in private companies?
- Can we change rules that mandate the use of outdated technology in, for example, our recordkeeping rules so that financial institutions can incorporate new technology and thus lower the costs of the services they provide?
- Can we allow more experimentation in the way that funds and investment advisers communicate with investors?
- Can we reexamine our assumptions about the types and methods of disclosure we require in light of the enormous changes in communication technology that have occurred since the federal securities laws were written in the 1930s?
- Can we permit more issuer communication with investors, which perhaps could open the door to a back-and-forth style of disclosure facilitated by online chats and message boards?
Although the Commission has spoken indirectly through a number of enforcement actions, “enforcement actions are not my preferred method for setting expectations for people trying to figure out how to raise money,” said Peirce. The enforcement actions found that the token offerings at issue were securities offerings, but token offerings do not always map perfectly onto traditional securities offerings. Again, the decentralized nature of blockchain networks plays a role, as functions traditionally completed by people designated as “issuers” or “promoters” under securities laws may be performed by a number of unaffiliated people, or by no one at all.
Mapping the framework. In calibrating its regulations, the SEC must take care not to cast the Howey net so wide that it swallows the “efforts of others” prong entirely, said Peirce. A forthcoming paper by Georgetown Law professor Chris Brummer argues that ICOs have certain features that make the regulatory framework applicable to IPOs inappropriate. Congress may step in and resolve the matter by requiring that at least some digital assets be treated as a separate asset class, as a bill recently introduced in the House by Congressmen Warren Davidson (R-Ohio) and Darren Soto (D-Fla) does, provided the token truly operates in a decentralized network.
Warning that her “antennae will go up when apparently legitimate projects cannot proceed because our securities laws make them unworkable,” Peirce said the SEC ought not to assume that absent the application of the securities laws to the world of tokens, there would never be any order, since the market imposes its own discipline regarding disclosures. Peirce is also concerned that the SEC’s approach to exchange-traded products based on bitcoin or other cryptocurrencies “borders on merit-based regulation,” and the agency should avoid substituting its own judgment for that of potential investors.
“We rightfully fault investors for jumping blindly at anything labeled crypto, but at times we seem to be equally impulsive in running away from anything labeled crypto,” said Peirce. “We owe it to investors to be careful, but we also owe it to them not to define their investment universe with our preferences.”