By Amy Leisinger, J.D.
In a virtual address before Blockchain Association Singapore, SEC Commissioner Hester Peirce noted that innovation can be both exciting and messy. Regulators can and should be objective third parties, allowing room to grow while incentivizing mitigation of harmful consequences. According to the official, however, regulators like the Commission seem to quickly deem blockchain and crypto developments dangerous or non-beneficial without looking for ways to "brake" potential problems without "breaking" the chain of technological evolution.
Regulatory efforts. Affectionately referred to as "Crypto-Mom," Peirce noted that investor protection includes ensuring the availability of a wide range of investment opportunities that fit a variety of investment objectives. Capital formation transforms lives and communities, and disruptive technologies can aid in these efforts and keep markets fair, orderly, and efficient, she explained. Enforcement actions can be instructive for market participants, according to the commissioner, but this is not the means by which the SEC should create new rules.
"Where there is ambiguity, we try to provide guidance before bringing enforcement actions," including so-called 21(a) reports shining a light on conduct that violates the securities laws, Peirce stated. The most notable of these is the DAO report applying the framework from the Howey case. The DAO report put token issuers on notice that, if money is raised for an enterprise by selling investment contracts, the securities offering framework applies. Further, the SEC staff has issued guidance identifying "characteristics" to consider when analyzing whether an offering of digital assets may involve a securities offering. The SEC also continues to offer "hints" on safety standards via enforcement action, but innovators are ultimately is left to guess at the path to compliance, she said.
Telegram case. Peirce opined that last month’s settlement with Telegram represented an "unsatisfying culmination of an enforcement action" that she did not support. In January 2018, Telegram began to raise capital to launch a blockchain called the "Telegram Open Network" (TON). Telegram raised $1.7 billion via agreements for the purchase of digital-asset securities called Grams, which would be created upon the launch of TON. Telegram committed to deliver the Grams to purchasers in conjunction with TON’s launch; upon delivery, purchasers would then be able to resell the Grams on the open market.
Telegram made good faith efforts to comply with the federal securities laws in raising funds to build its network and engaged extensively with the SEC staff, Peirce explained. According to Telegram, the first stage of raising funds from accredited investors in a private offering involved an exemption from registration requirements. However, she noted, the launch of the TON blockchain and delivering the Grams to the accredited investors led to more issues. The accredited investors could resell the Grams, subject to certain restrictions, and, according to Telegram, resale transactions would not involve a security, but instead a digital currency.
However, the district court in the Telegram case (at the SEC’s urging) determined that the entire transactional sequence and resale constituted a single scheme that constituted an "investment contract" under the securities laws.
Once tokens have a consumptive use, they should be able to be sold to purchasers outside of a securities transaction, Peirce explained. By focusing the Howey analysis exclusively on the original transaction, the factual reality of the transaction was lost, according to the commissioner. Further, she contended, Telegram’s major operations were not in the United States, but district court’s clarified that its decision applied worldwide. Telegram chose to abandon its project and settle with the SEC, curbing potential innovation, Peirce explained.
"Who did we protect by bringing this action?" the commissioner asked.
Innovation in digital assets will continue to challenge regulators, and the SEC must attempt to provide more cautious innovators guidance on how to avoid problems and implement "braking" technology," she concluded.