SEC Commissioner Peirce Introduces Safe Harbor Plan for Digital Token Sales | Practical Law

SEC Commissioner Peirce Introduces Safe Harbor Plan for Digital Token Sales | Practical Law

SEC Commissioner Hester Peirce presented her proposal for a token safe harbor, which would grant developers of digital networks a three-year grace period to allow them to develop the platform without securities laws concerns.

SEC Commissioner Peirce Introduces Safe Harbor Plan for Digital Token Sales

Practical Law Legal Update w-023-9928 (Approx. 5 pages)

SEC Commissioner Peirce Introduces Safe Harbor Plan for Digital Token Sales

by Practical Law Corporate & Securities
Published on 11 Feb 2020 • USA (National/Federal)
SEC Commissioner Hester Peirce presented her proposal for a token safe harbor, which would grant developers of digital networks a three-year grace period to allow them to develop the platform without securities laws concerns.
On February 6, 2020, SEC Commissioner Hester Peirce presented her proposal for a token safe harbor in a speech at the International Blockchain Congress. Although this proposal is solely Commissioner Peirce's own and not approved as a formal SEC proposal, the Commissioner hopes to spark the conversation to develop a formal rule.
Commissioner Peirce described the current status of tokens as a "regulatory Catch-22" where would-be networks are unable to get their tokens out into distribution because the tokens are potentially subject to securities laws. However, the would-be networks are unable to mature into a functional or decentralized network that is not dependent on a single individual unless the tokens are distributed to and freely transferable among potential users, developers, and participants in the network.
Although the proposal would extend to centralized networks as well, the proposal is primarily directed to assist projects that are looking to build a decentralized network but are experiencing difficulty bridging the legal gap. The safe harbor is also intended to be available for tokens that were previously sold in a registered offering or pursuant to a valid exemption under the Securities Act of 1933 (Securities Act). In these cases, a safe harbor may be necessary to permit secondary trading to occur and to distribute tokens more widely into the hands of potential users.
In the appendix to the speech, Commissioner Peirce has included a detailed description of the safe harbor proposal. For the purpose of the proposal, the term "token" is defined in the appendix as a digital representation of value or rights:
  • That has a transaction history that:
    • is recorded on a distributed ledger, blockchain, or other digital data structure;
    • is confirmed through an independently verifiable process; and
    • resists modification or tampering.
  • That is capable of being transferred between persons without an intermediary.
  • That does not represent a financial interest in a company, partnership, or fund, including an ownership or debt interest, revenue share, or entitlement to any interest or dividend payment.
The safe harbor would provide network developers with a three-year grace period in order to provide time to facilitate participation in and the development of a functional or decentralized network by exempting:
  • The offer and sale of tokens from the provisions of the Securities Act, other than the antifraud provisions.
  • The tokens from registration under the Securities Exchange Act of 1934 (Exchange Act).
  • Persons engaged in certain token transactions from the definitions of "exchange," "broker," and "dealer" under the Exchange Act.
In order to take advantage of the safe harbor, the following conditions must be met:
  • The initial development team must intend for the network on which the token functions to reach network maturity, defined as either decentralization or token functionality, within three years of the date of the first token sale and undertake good faith and reasonable efforts to achieve that goal.
  • Certain key information must be disclosed on a freely accessible public website including but not limited to:
    • source code and transaction history;
    • token economics, describing the purpose, protocol, and operations of the network;
    • the plan of development;
    • prior token sales;
    • the initial development team and certain token holders;
    • any secondary trading platforms on which the token trades; and
    • any incidence in which a member sells five percent or more of her originally held tokens over any period of time.
  • The token must be offered and sold for the purpose of facilitating access to, participation on, or the development of the network. This condition clarifies that the safe harbor is not appropriate for debt or equity securities that are posing as tokens.
  • The team would have to undertake good faith and reasonable efforts to create liquidity for users.
  • The team would have to file a notice of reliance on EDGAR within 15 days of the date of the first token sale in reliance on the safe harbor.
The safe harbor, however, is not intended to provide immunity from fraud in connection with token sales. The safe harbor would not be available to a team if one or more of its members is subject to disqualification as a bad actor under the securities laws. Additionally, the safe harbor would reserve the SEC's antifraud authority with respect to token sales under the safe harbor. These provisions are designed to ensure that the SEC can bring suit against a team that sets out to defraud token purchasers by materially misrepresenting or omitting key information.
For further details on SEC regulation of digital assets, see Practice Note, Understanding the SEC's Digital Asset Framework and Approach to Digital Asset Regulation.