Interpretation of SEC Commissioner Hester Peirce's "Token Safe Harbor Proposal" (with translation of the proposal)

Source of this article: Block Technology Research and Supervision (id: BlockchainDirect)

Author: Financial Technology Research Center, Tsinghua University Block Chaining

On February 6, 2020, Hester Peirce, a member of the United States Securities and Exchange Commission (hereinafter referred to as the SEC), presented at the International Blockchain Conference in Chicago entitled "Blank Operations: A Proposal to Fill the Gap Between Regulation and Decentralization" (Running On Empty: A Proposal To Fill The Gap Between Regulation and Decentralization, and proposed the "Token Safe Harbor Proposal" [1] , Peirce said that the proposal is to encourage crypto innovation and solve the problem of crypto companies. To the regulatory dilemma.

As one of the five SEC members, Peirce has always supported the development and innovation of encryption technology. This proposal has also attracted widespread attention and discussion in the crypto community. It involves concerns about fraud, unclear decentralized standards, and other issues. Relations with other laws, allowing issuers to provide liquidity directly, and reshaping safe harbors according to specific contractual obligations, etc. Peirce also responded to feedback in the media on February 18 [2] . The "Token Safe Harbor Proposal" has not yet been formally proposed by the SEC, and Peirce is still receiving feedback and suggestions from various parties.

Regulatory dilemma for crypto companies

 

Peirce suggested in her speech that regulatory issues should be considered from the perspective of establishing observable rules for people in good faith. She believes that the current SEC's regulation of the crypto industry cannot meet the needs of the industry, and crypto companies face a regulatory dilemma. On the one hand, in the process of establishing a functional network or decentralized network, crypto companies may be subject to the regulation of the US federal securities laws, which will hinder the development of encrypted networks into functional or decentralized networks; on the other hand, the SEC Currently, the Howey test is used to review token transactions, and it is difficult for crypto companies that are still struggling but have not yet built a functional network or a decentralized network to pass the Howey test.

Peirce believes there are two problems with the Howey test. The first is to confuse the token with the investment contract. Even if the contract for the sale of the token is an investment contract, the object of the contract may not have the characteristics of securities. The second is that the test depends on the subjective will of the investor and ignores the investor. The objective nature of the invested items depends on the subjective will of the investor, and the SEC supervision burden is too heavy.

To address the regulatory dilemma, crypto companies currently take three approaches, but all have risks. The first way is to avoid becoming a security, only publishing white papers, open source code, and mining genesis blocks, and then waiting for users to grow naturally, but it is still difficult to prove that the token has functions before it has a wide range of users; the second way is to obtain registration Or exemption from registration. There is currently no successful case of token securities registration in the United States. Enterprises can obtain exemptions according to Regulation A and Regulation D, such as Blockstack PBC, a blockchain startup that has obtained Regulation A exemption, but for crypto companies, exemption The cost is too high, and the exemption conditions will also limit the core advantages of the network without intermediary transactions. The third way is to conduct business outside the United States. This way, it is difficult to ensure that the business does not occur in the United States and will cause damage to the United States economy. [3] .

Positioning of the token safe harbor proposal

 

Peirce believes that the token safe harbor proposal is not a non-objection letter from the committee, but a statute. The SEC has previously issued a letter of no objection to the centralized network. Compared to regulations, the letter of no objection promises that the SEC will not take enforcement measures against it, and the regulations will clearly indicate the applicability of the law. The proposal has two goals. The first goal is to protect investors, such as the implementation of information disclosure aimed at investors' needs and the retention of anti-fraud provisions of the securities law. The second goal is to provide policy flexibility for innovation and development.

The main content of the token safe harbor proposal is to provide the initial development team with a three-year period. During this period, the team can obtain the exemption from the registration requirements of the federal securities law as long as the conditions are met, develop a functional or decentralized network, and improve User engagement. Teams who want to be exempt need to meet five conditions (see the original proposal in the appendix for details):

• The team must plan the network where the token is located so that it reaches network maturity;

• Disclose key information, such as source code, transaction records, consensus mechanism, development plan, number of tokens owned by team members, major event changes, etc., on a freely accessible public network;

• The purpose of raising and selling tokens is to develop the network and increase user participation;

• Create mobility for users;

• Submit credible publicity in compliance with EDGAR rules

Community feedback

 

According to Peirce's article published on Coindesk on February 18, the suggestions currently received include: first, clarifying how Safe Harbor interacts with the laws of other domestic and foreign jurisdictions; second, allowing issuers to provide liquidity directly, Instead of being provided through a third-party trading platform; Third, reshape the safe harbor around specific contractual obligations.

Several crypto companies have supported the proposal. Catherine Coley, CEO of Binance, the US digital asset market, believes that the proposal may lead to a "breakthrough development" of US crypto technology; Katie Biber, general counsel of crypto asset custodian Anchorage, believes that the safe harbor framework is "important to help flourish innovation As a next step, we welcome the (regulatory) clarity it provides. "

Lawyers also expressed concern about the proposal. Byrne & Storm law firm Preston J Byrne said that the "decentralized" standard on which the proposal relies is not yet clear, and the "decentralized" test standards currently used by the SEC and proposed in the future cannot be quantified, or even Legally, it is still ambiguous. In addition, the rights of retail investors are not guaranteed. A "safe harbor" makes it difficult for retail investors to distinguish between legal projects like Blockstack and well-known scams like OneCoin within 3 years [4] .

The "safe harbor" system in American law is essentially an exemption system. The law cannot respond to similar vague, abstract, and complex fields. Otherwise, on the one hand, market entities (mainly financing parties) are not fully protected and face legal or regulatory threats. Investor costs and regulatory costs affect market efficiency. The interview with Forbes in Peirce mentioned that the mission of the SEC is to promote capital formation first, and then to carry out an orderly fair market and investor protection. Although there are still many problems with the "Token Safe Harbor Proposal", to a certain extent, the "safe harbor" is actually a protection for investors, including keeping open to investors' choices. The token project is a gray area, and the main responsibility of the regulator is to define the correct boundary where the jurisdiction is located [5] .

Appendix: Proposal Translation

 

Token Safe Harbor Proposal

Commissioner Hester M. Peirce's Office

February 6, 2020

Proposed Article 195 of the Securities Law-Time-Limited Exemption of Tokens.

Preliminary note:

1. Decentralized ledger technology can be used to raise and sell digital assets (such as tokens) to raise funds or for other purposes. Depending on the particular facts and circumstances, U.S. federal securities laws may apply to such transactions, but do not take into account the form of organization or technology used to achieve this particular offering or sale.

The analysis of whether tokens are raised or sold as securities is not static and, strictly speaking, it is not an inherent property of digital assets. Tokens may be initially raised and sold as securities because it is packaged in transactions involving investment contracts, but if tokens are subsequently raised and sold outside of the investment contract, this identification may change over time. For example, if the purchaser can no longer reasonably expect a person or group to make the necessary management or operating efforts, the token sale may no longer be the sale of an investment contract.

However, in order for the network to mature into a functional or decentralized network, that is, the network does not rely on any individual or group to perform the necessary management or management efforts, the tokens must be distributed to potential users, programmers, and the network Participants and can trade freely. In addition, the secondary transactions of tokens usually provide the necessary liquidity for network users and contribute to the development of the network. Applying federal securities laws to these transactions would undermine the ability of the network to mature and prevent the tokens sold as securities from turning into non-secure tokens that function in the network.

Therefore, Safe Harbor aims to provide the initial development team with a three-year period, during which they can increase user engagement, develop functional or decentralized networks, and obtain federal securities law registration requirements as long as they meet the conditions Exempt. Safe Harbor also aims to protect token buyers by requiring disclosure of information that addresses buyer needs and retaining the application of anti-fraud provisions in federal securities laws.

After the three-year period ends, the initial development team must determine whether the token transaction involves the raising or sale of securities. If the network has matured into a functional or decentralized network, token transactions may not constitute securities transactions. The definition of network maturity is designed to provide clarity in assessing specific facts and circumstances in order to analyze whether token transactions are no longer considered securities transactions.

2. Article 195 Safe Harbor is not exclusive. Individuals who do not meet all applicable conditions of section 195 can still apply for any other available exemption from the raising and sale of securities under the Securities Act of 1933.

(A) Exemptions. Except as expressly provided in section (d) of this section, the Securities Act of 1933 does not apply to any offering, sale, or transaction involving tokens as defined herein if the initial development team meets the following conditions: (1) Initial The development team aims to make the tokens function on their network within three years from the date of the first sale of the tokens, to allow the network to reach the network maturity defined in this agreement, and to make credible and reasonable efforts to achieve this goal (2) The disclosure required by section (b) of this section must be provided on a publicly accessible free website. (3) The purpose of raising and selling tokens must be to promote network access, participation, or development. (4) The initial development team plans and will create credible and reasonable efforts for users to create liquidity. If the initial development team wants a secondary transaction of the token on the trading platform, the secondary trading platform needs to be able to demonstrate compliance with all applicable federal and state laws and regulations regarding currency transmission, anti-money laundering and consumer protection. (5) The initial development team submits a credible public notice in accordance with the provisions of Article (c) of this section.

(B) Disclosure. The initial development team must provide the information described below on a freely accessible public website. Any change to the information described in paragraphs (1-4), (6) and (7) and paragraph (8) from the date of submission of a credible public notice under section (c) of this section The information described must be provided on the same freely accessible public website as soon as practicable. (1) Source code. A command-line text list that can be compiled or assembled into an executable computer program for network participants to use to access the network, improve code, and confirm transactions. (2) Transaction records. A narrative description of the steps necessary to independently access, search, and validate web transaction history. (3) Token Economics. A narrative description of the purpose of the network, the protocol, and its operation. Such disclosures should include at least all of the following: (i) information explaining the launch and supply process, including the number of tokens issued during the initial distribution, the total number of tokens created, the timetable for the issuance of tokens, and the unissued tokens The total number; (ii) information detailing the method of generating or mining tokens, the process of token destruction, the transaction verification process, and the consensus mechanism; (iii) explaining the governance mechanism for implementing protocol changes; and (iv) sufficient information for the first The three parties make tools (e.g., blockchain or distributed ledger) for verifying the history of token transactions. (4) Development plan. Current status and timeline of network development to show how and when the initial development team intends to achieve network maturity. (5) Tokens previously sold. Date of sale, number of tokens sold, any restrictions or regulations on the transferability of the tokens sold, the amount raised, and the type of consideration received. (6) Initial development team and specific token holders. Provide the following information: (i) the name and relevant experience, qualifications, characteristics, or skills of each of the members of the initial development team; (ii) the number of tokens or rights of the tokens owned by each member of the initial development team, and the rights to these people A description of any restrictions or regulations on the transferability of the tokens held; and (iii) if members of the initial development team are entitled to receive token rewards in a way different from the way in which tokens are obtained by third parties, please describe the the way. (7) Trading platform. Determine a secondary trading platform for token transactions within a known range. (8) The initial development team sells tokens. Each time a member of the initial development team sells 5% of the tokens specified in paragraphs (b) (6) (ii) of this section, please indicate the date of sale and the number of tokens sold And the identity of the seller.

(C) Submit credible publicity. An initial development team that raises or sells tokens under Article 195 must submit a credible public announcement in the safe harbor within 15 calendar days after the date of the first token sale based on the safe harbor, unless the deadline for the period is Saturday, Sunday, or U.S. federal holiday, in which case the deadline is the next business day. (1) The announcement must include the following information: (i) the name of the initial development team, including each member; (ii) the date of the first token sold under the safe harbor; (iii) a person authorized by the initial development team Examine proof that it meets the conditions of this section; and (iv) accessible websites required by the disclosure requirements of Article (b). (2) The initial development team must, within the practicable scope, submit amendments to the previous public announcement to reflect major changes in the information provided in a timely manner. (3) A credible public notice must be submitted to the Securities and Exchange Commission in electronic format in accordance with the EDGAR (Electronic Data Collection, Analysis, and Retrieval System) rules specified in Article ST of the Securities and Exchange Commission.

(D) Restrictions. The exemptions provided by section (a) of this section do not apply to the provisions of section 12 (a) (2) or section 17 of the Securities Act 1933.

(E) Exemption period. The relief period provided in this section is three years from the date on which the first token was sold in a safe harbor. If the initial development team complies with Article (f) of this section, the exemption will terminate three years after the date on which the initial development team submitted the credible publicity.

(F) Tokens previously sold. If the conditions of Article (a) (1), (2), (4) and (5) are met, the provisions of this section may apply to tokens previously sold under a valid exempt registration. The credible publicity required by Article (c) of this section must be submitted as soon as practicable.

(G) Definition of qualified purchaser. For the purposes of section 18 (b) (3) of the Securities Act of 1933, "qualified purchaser" means any person from whom tokens are raised or sold under section (a) of this section.

(H) Failed. If any of the initial development teams or their individual members are ineligible under Rule 506 (d), this clause shall not exempt any initial development team's tokens. (I) Definition. (1) Tokens. A token is a digital representation of a value or right. (I) has a history of transactions: (A) recorded on a decentralized ledger, blockchain or other data structure; (B) confirmed transactions through an independently verifiable process; And (C) refuse to modify or tamper with the transaction; (ii) be able to transfer from person to person without an intermediary; and (iii) not represent the economic interests of the company, partnership, or fund, including ownership or debt interests , Revenue share, any right to pay interest or dividends. (2) Initial development team. Any person, group, or entity that provides the necessary management for the development of the network before the network reaches network maturity. (3) Network maturity. Network maturity is the state of a decentralized network or a functional network. It can be achieved when the network is in one of the following situations: (i) There is no control right, and there is no reasonable possibility that it can be jointly shared by any individual, entity, group, or entity alliance. Controlling unilateral changes or controls; or (ii) functional, such as holders using tokens for value transmission and storage, or proving control of tokens, or using applications running on the network, or consistent with network functions The other way. This definition is not meant to exclude the implementation of network changes through a predetermined process in the source code through the use of consensus mechanisms and approval by network participants.

Provisions 3a1-2 of the Proposed Transaction Law. The definition of "transaction" in section 3 (a) (1) of the Act is exempted.

Organizations, associations or groups that are constructing, maintaining, or providing a market, or promoting the matching of buyers and sellers of tokens that meet the requirements of Article 195 of the Securities Law, or otherwise perform such functions normally performed by a stock exchange on such tokens, Not subject to the definition of the term "transaction".

3a4-2 of the Proposed Transaction Law. People engaged in token transactions are exempt from the definition of "broker". The definition of the term "broker" can be waived as long as someone engages in the business of token transactions that meets the requirements of section 195 of the Securities Act of 1933.

3a5-4 of the Proposed Transaction Law. People engaged in token transactions are exempt from the definition of "dealer". A person is exempted from the definition of "dealer" if he or she conducts a token sale business through a broker or other means for that person's own account that satisfies Section 195 of the Securities Act of 1933.

12h-1 (j) of the proposed Transaction Law. Exemption from registration under Article 12 (g) of the Act. Issuers shall not be subject to the provisions of section 12 (g) of the Act for the following securities: New section (j): (j) Any tokens raised and sold under section 195 of the Securities Act 1933 .

[1] Secs Cryptomom Proposes Safe Harbor Framework for Token Projects, Cointelegraph, Helen Partz, https://cointelegraph.com/news/secs-cryptomom-proposes-safe-harbor-framework-for-token-projects [2] Hester Peirce: Tell Me How to Improve My Safe Harbor Proposal, Coindesk, Hester Peirce, https://www.coindesk.com/hester-peirce-tell-me-how-to-improve-my-safe-harbor -proposal [3] Running on Empty: A Proposal to Fill the Gap Between Regulation and Decentralization, SEC speeches, commissioner Hester M. Peirce, https://www.sec.gov/news/speech/peirce-remarks-blockress-2020-02 -06 [4] Peirce's Safe Harbor is Worth a Look, But It May Not Be Worth the Effort, Coindesk, Preston J Byrne, https://www.coindesk.com/crypto-firms-should-get-behind-peirces-safe- harbor-proposal-even-if-its-unlikely-to-become-law [5] SEC Commissioner Hester Peirce Talks Safe Harbor, Crypto Tokens, Decentralization And Pumping Gas, Forbes, Jason Brett, https://www.forbes.com/sites/jasonbrett/2020/02/11/sec-commissioner-hester- peirce-talks-safe-harbor-crypto-tokens-decentralization-and-pumping-gas / # 24a0b14e69d4