FINLAW: Peirce’s proposed safe harbor for three years of crypto (almost) regulatory immunity unlikely to become reality; Telegram Court proceeding presents opportunity for clarification of law
SEC Commissioner and Crypto Mom Hester Peirce completed her adoption of the crypto industry last week. Peirce single handedly proposed a safe harbor for crypto/digital asset offerings excusing all regulatory violations except fraud. The safe harbor proposal provides regulatory immunity except for fraud to crypto offerings for a period of three years to enable them sufficient time to become decentralized and to no longer involve a security. The proposal is interesting and shows that at least one of the five SEC Commissioners see the need for dramatic action to preserve the possibility of a crypto currency industry here in the United States. As Peirce correctly noted, the federal securities laws and SEC enforcement actions have stymied what many believe to be an important budding technology and industry.[1]
The safe harbor is applicable to both centralized and decentralized networks, and can generally be summarized as follows: A three year grace period for network developers seeking to develop a decentralized network, including an exemption from a) the offer and sale provisions of the 1933 Act, b) the registration provisions under the 1934 Act, and c) the definitions of “exchange,” “broker” and “dealer” under the 1934 Act, plus d) state blue sky law preemption. There are, however, required disclosures, conditions to establish good faith, and the anti-fraud provisions of the federal and state securities law remain intact.[2]
Of note is the condition set forth in the proposed safe harbor that the network developers must undertake reasonable efforts to provide “liquidity” to network users. This is generally done through a network token being placed on a trading platform to enable secondary trading, an action implicitly encouraged by the safe harbor. The focus on liquidity and secondary trading, however, complicates what could have otherwise been a simpler three year grace period. The secondary trading of tokens carries with it the prospect of profit, and as Peirce noted, strongly implies a security offering[3] which, in turn, naturally calls for the protections of the securities law. Even if we can carve out a safe harbor for crypto that exempts it from Howey,[4] the reality remains that there needs to be some protection to investors. While Peirce’s proposal preserves the ability of the SEC to file fraud charges, the secondary trading liquidity mechanism raises further risks to investors. The SEC has been largely concerned with manipulation occurring in the secondary trading of crypto assets, discussed most publicly with Bitcoin. With this concern, it is unlikely the SEC will encourage secondary trading of crypto assets absent protections against manipulation like those afforded by traditional U.S. securities exchanges. This aspect of Peirce’s proposal (and perhaps the remainder as well) is thus likely to be rejected by the majority of Commissioners.
In the short term, a nearer prospect for clarification of law rests with a US District Court Judge in the Southern District of New York who will shortly issue a decision on whether a “gram,” the token in Telegram’s ICO, is a security. The Court last week asked the CFTC for its input on “the issues presently before the Court” (presumably whether the CFTC views gram to be a commodity, and whether a token can be both commodity and security at the same time). Courts traditionally have been the place where SEC interpretations of law are tested. This case is no exception, and proponents in the industry who continue to await regulatory guidance may focus their attention on whether a U.S. Court clarifies how network developers may build a crypto industry here in the United Sates.
The information and materials in this blog posting are provided for general informational purposes only and are not intended to be legal advice. The issues discussed include complicated areas of law and legal advice should be obtained from a securities attorney about your specific circumstances.
Scott Andersen is principal at finLawyer.com (Andersen, PC). He has also been Deputy Regional Chief Counsel at FINRA, Enforcement Director at the NYSE, Co-Chief of the Securities Prosecutions Unit of the NY Attorney General’s office, and Asst. Attorney General for the State of New York. In these roles, he has investigated, prosecuted and supervised criminal, civil and regulatory securities enforcement actions for over nineteen years. He concentrates his practice on SEC, FINRA and state regulatory defense and securities regulatory counseling, and works with broker-dealers, investment advisers, crowdfunding portals, funding platforms, and fintech providers on regulatory compliance matters.
[1] Commissioner Hester M. Peirce, Running on Empty: A Proposal to Fill the Gap Between Regulation and Decentralization, February 6, 2020.
[2] Token Safe Harbor Proposal, Office of Commissioner Hester M. Peirce, February 6, 2020
[3] Commissioner Hester M. Peirce, Running on Empty, supra.
[4] SEC v. Howey Co., 328 U.S. 293 (1946).