SEC Commissioner Hester Peirce has unveiled her proposal to implement a “safe harbor” for crypto startups, allowing them a three-year grace period after their initial coin offerings to reach a level of decentralization sufficient to pass the Howey test.
The Howey test is the four-part Supreme Court test for determining whether certain transactions qualify as “investment contracts,” otherwise known as securities offerings.
Peirce—a Republican commissioner whom blockchainers have nicknamed “Crypto Mom” because of her ongoing support for cryptocurrencies—gave a talk to the International Blockchain Congress in Chicago on Thursday, where she announced that she was proposing a new rule.
In a speech entitled “A Proposal to Fill the Gap Between Regulation and Decentralization,” Peirce effectively argued that the laws that have been in effect since the 1930s and were put in place to protect investors are stifling innovations in blockchain and cryptocurrencies.
“We have created a regulatory Catch-22,” she said. “Would-be networks cannot get their tokens out into people’s hands because their tokens are potentially subject to the securities laws.”
In the U.S., pretty much all ICOs are deemed to be securities, with very few exceptions. Several projects have argued that their tokens are not securities because they serve a vital function in the network. The concept of a “utility token,” however, was put to rest in the SEC’s Munchee order in December 2017, which basically said calling something a utility token does automatically unmake it a securities offering.
Since then the SEC has come down hard on several projects. Notably, it charged messaging app Kik with conducting a $100 million unregistered ICO in 2017. The agency is also currently suing social network Telegram to halt a $1.7 billion unregistered token offering. And others, like Block.one, have agreed to multi-million-dollar fines.
Many crypto entrepreneurs argue that strict SEC rules have forced projects to relocate to more lenient jurisdictions, like Switzerland and Singapore, thereby pushing innovation outside of the country. However, others say the SEC has not done enough to reign in the questionable and unwieldy ICO projects that raised an estimated $5.6 billion in 2017 alone.
Crypto Mom’s proposal
If Pierce’s safe harbor proposal, labeled Rule 195, is adopted by a majority vote with the SEC’s other four commissioners, it would set up guidelines for crypto projects to raise funds through a token sale. Following a three-year grace period, the Howey Test will be applied to determine whether the token is sufficiently decentralized—and therefore not a security.
Specifically, Peirce’s safe harbor would give network developers breathing room to “facilitate participation in and the development of a functional or decentralized network,” exempt from a slew of securities laws, so long as development teams meet four conditions. That means coins would be free to trade. Exchanges and brokers would also get broad exemptions.
But first, a project must intend for the network the token runs on to reach maturity—”defined as either decentralization or token functionality”—within 36 months of the date of the first token sale. “Once the tokens are actually in use to buy and sell the services for which they were intended, the securities laws will be clearly inapplicable,” Peirce wrote.
Second, the team would have to disclose key information about the project on a public website. Such information would include the source code and transaction history, a roadmap showing the plans to achieve network maturity, and details about financing, among other things.
Third, the token must be offered and sold for the purpose of “facilitating access to, participation on, or the development of the network.” And, as a fourth and final requirement, the team would also have to make reasonable efforts to create liquidity for users and “file a notice of reliance.”
Of course, the SEC’s enforcement arm will remain on the lookout for other violations like fraud in the sandbox, she added.
Peirce has invited feedback on her proposal. One person who might have some particularly strong feedback is SEC Chairman Jay Clayton, who has come down hard on ICOs and notably said in the past: “I believe every ICO I’ve seen is a security.” Peirce fills a term that expires on June 5.
I am launching a market for decentralized trading of synthetic non-recourse multi-chain protocol option tokens using semi-delegated proof of proof of stake. Send money.— Palley (@stephendpalley) February 6, 2020
Updated March 13, 2020 to add hyphen to “Catch-22.”