By Amy Leisinger, J.D.
SEC Commissioner Hester Peirce has released a statement on GitHub providing an updated version of her token safe-harbor proposal from February 2020. According to the commissioner, the safe harbor is designed to provide network developers with a three-year grace period within which they can facilitate participation in and the development of a decentralized network while exempted from registration provisions.
"The updated version reflects constructive feedback provided by the crypto community, securities lawyers, and members of the public," she said.
Proposal. Last year, Commissioner Peirce laid out plans for a safe harbor for network developers and tokens to address the difficulties of distributing tokens without implicating the federal securities laws. The safe harbor would allow a three-year registration exemption for network development. In a speech, the commissioner considered the issues associated with crypto-entrepreneurs building decentralized networks while attempting to ensure that their token distributions do not fall under registration obligations.
According to Peirce, the Commission’s approach made it difficult for a company to distribute a token without running into registration questions. As such, the commissioner proposed a safe harbor to address the uncertainty applicable to tokens while still protecting investors. Peirce noted that crypto-entrepreneurs are seeking to build decentralized networks in which a token serves as a means of exchange or a function on the network and that they need to get the tokens out to others.
However, she said, as the SEC applies the Howey test to determine whether a security is involved in a transaction, the distinction between the token and a potential investment contract gets blurred.
"We have created a regulatory Catch 22," Peirce opined. Networks cannot get their tokens to others because they may be deemed securities, but they cannot mature into functional, decentralized networks efforts unless the tokens are distributed and transferable, the commissioner stated.
According to Peirce, a safe harbor for networks would address the uncertainty of the application of the securities laws to tokens and achieve investor protection while still providing sufficient regulatory flexibility to support innovation. The developers would be required to undertake good faith efforts to reach network maturity and would have to disclose key information on a freely accessible website, Peirce noted. Among other things, the safe harbor requires source code and transaction history to be publicly available, she said, and the development team would have to describe the number of tokens to be issued in the initial allocation and the total number created and/or outstanding, as well as the token release schedule.
"Once the network cannot be controlled or unilaterally changed by any single person, entity, or group of persons or entities under common control, the token that operates on that network will not look like a security," she explained.
Updates. However, there is more work to be done, Peirce said. Three changes mark the updated version, according to the official. To enhance token purchaser protections, the safe-harbor proposal now requires semi-annual updates to the plan of development disclosure and a block explorer. In addition, the safe harbor proposal now includes an exit report requirement to include either an analysis by outside counsel explaining why the network is decentralized or functional or an announcement that the tokens will be registered, the commissioner explained. The exit report also would require guidance on outside counsel’s analysis on decentralization. The goal is to strike a balance between providing a manageable number of guideposts while maintaining sufficient flexibility, Peirce stated.
"Now, as a new Chairman is coming into the SEC with a new agenda, is the perfect time for the Commission to consider afresh how our rules can be modified to accommodate this new technology in a responsible manner," she concluded.