Crypto community has questions for SEC's 'safe harbor'

Author: John Crabb | Published: 14 Feb 2020
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safe harbour

Last week, Securities and Exchange Commission (SEC) commissioner Hester Peirce  released long-awaited 'safe harbor' proposals that set out how the agency will regulate part of the crypto markets in the US.

The proposed safe harbor would give digital token projects three years to demonstrate that the tokens they issue are not securities, and therefore should not be subject to the SEC's securities regulations.

The hotly anticipated proposals were met with approval from many in the crypto community. However, a week on, many prominent names in the sector have had time to deep-dive into Peirce's proposals and have now raised a range of concerns.

"Thinking more about Hester Peirce's proposal for a token safe harbor, which really does advance the ball re US SEC issues," wrote Caitlin Long on Twitter, a Wyoming-based blockchain expert, "there are issues that still need to be addressed – the basic one is whether the tokens are presumed securities during the safe harbor or not."

See also: The rise of token technology explained

The safe harbor

During a speech in Chicago last week, Peirce discussed the problem at hand. Many crypto entrepreneurs are seeking to build decentralised networks in which a token serves as a means of exchange on, or provides access to, a function of the network, she said.

"In the course of building out the network, they need to get the tokens into the hands of other people. But these efforts can be stymied by concerns that such efforts may fall within the ambit of federal securities laws," adding, "the fear of running afoul of the securities laws is real. Given the SEC’s enforcement activity in this area, these fears are not unfounded."

As it stands, entrepreneurs looking to issue tokens can be hesitant to do so in fear of breaching the SEC's stringent regulatory regime.

"We have created a regulatory catch-22"

"We have created a regulatory catch-22," said Peirce. "Would-be networks cannot get their tokens into people’s hands because their tokens are potentially subject to the securities laws. The laws cannot be ignored, but neither can we, as securities regulators ignore the conundrum our laws create."

It’s a case of investors causing issue for the very entrepreneurs they are investing in. "Most folks buying tokens when they are first available are not in fact immediately acquiring them for a 'consumptive’ purpose," Lewis Cohen, co-founder at DLx Law, wrote on Twitter. "They believe that, over time, the related network will grow and they will be able to sell the tokens for a profit."

But what of third parties who want to use the tokens for their intended purpose, Cohen asked – and what about exchanges that want to provide access to tokens?

"If adopted, the safe harbor proposal will address these secondary sale transactions by persons not affiliated with the initial development team," he said. "There is no policy reason why such asset sales should comply with the securities laws."

See also:  US fintech regulation: where do we stand?

Long, too, suggests the proposals are positive, but points out some issues: "the proposal opens at least two cans of worms – the custody question, and creates problems for issuers outside the US," she wrote, adding that many countries recognise that tokens aren’t necessarily securities, but if the US thinks they are, then other countries may follow.

"This proposal moves the ball, but there’s still a big catch-22 preventing the security token industry from flourishing in the US. But, on the other hand, if the tokens aren’t presumed securities during the three-year grace period, then they’re property," she added.

In the US, individual states, not the SEC, have jurisdiction over property – meaning the SEC would need to cooperate with each state for the proposal to work.

"This matters a lot, because property and securities are treated differently under commercial law (different negotiability, different ways of perfecting security interest, etc.)," wrote Long.

Others made similar points. "The first thing that struck me was the tone/mission statement implied," wrote Drew Hinkes, counsel at Cartlon Fields. "This looks like 'how do we make workable token sales that allow networks to develop?' not 'how do we apply the securities laws to issuers of instruments?' Is this a policy shift?"

In SAFT hands

Some commentators have questioned if the safe harbor proposal is a ratification of the Simple Agreement for Future Tokens (SAFT) framework. SAFT is an investment contract offered by cryptocurrency developers to accredited investors, which is considered a security and therefore is compliant with securities regulations.

They were first created to help new cryptocurrency entrepreneurs raise money without breaching financial regulations; specifically, the regulations that govern if the investment is a security or not.

Some expected Peirce's safe harbor to be a formal ratification or extension of the SAFT model. Others suggest it is not.

"It is a dramatic new approach to regulating token issuance ab initio"

"This is not an extension of the SAFT framework at all. It is a dramatic new approach to regulating token issuance ab initio. The SAFT framework looks downright conservative next to this," wrote Marco Santori, president and chief legal officer of digital asset platform

"For many, this proposal is far superior to the SAFT framework. It exempts from the registration requirements not only resales of tokens, but also primary issuance," he added. "By and large, under the SAFT framework that became standard in 2017/18, primary issuance of tokens in the US could only be to accredited investors. In contrast, this safe harbor proposal permits initial sales to the public right out of the gate…it gives retail the same early access as venture capital funds."

According to Jeffrey Amico, counsel at tech venture capital firm Andreessen Horowitz, if the safe harbor passes, "it would not only be very positive news for new token launches, but also for existing SAFTs that are sitting in regulatory limbo".

These points show that the proposals need work – far from unusual for this type of regulatory change.

In her speech, Peirce suggested that her office would be open to discussion.

"Hopefully, there is one point on which we can all agree: if you are in this space, it is critical to understand the arguments on both sides and to have an informed view on them," wrote Cohen. "The safe harbor proposal is the beginning of an important dialogue on this topic."

See also:  Head-to-head: Is Facebook’s Libra coin a positive development for crypto?