I recently had the pleasure to sit down and talk with SEC Commissioner Hester Peirce about the current landscape of digital assets, and how the SEC is working on making a clearer path for people in the space. See our discussion below for some valuable information and direction for anyone involved or interested in digital assets, security tokens, and digital securities.
Commissioner Peirce is known affectionately in the crypto community as “Crypto Mom” for her progressive outlook and push for sensible solutions that still allow for growth in the community. She recently released her Token Safe Harbor Proposal (Proposed Securities Act Rule 195) which is a very well thought out proposal to bridge the gap between regulation and decentralization.
The views expressed by Commissioner Peirce are her own and do not necessarily represent those of the Securities and Exchange Commission or her fellow Commissioners.
This interview has been edited for clarity.
RS: For someone trying to determine if the business model is a utility or a security, what would you say are the three most important elements to consider?
HP: Well I think that what I would suggest is that you take a look at the Howey test and determine where you fit in terms of whether you are selling the token to folks wrapped with a promise that you as a promoter are going to do something to make that token increase in value. If that is how you are promoting it, then I would say you need to study Howey carefully and determine which side of the line you fall on.
You can read more from the SEC about the Howey test below:
- Digital Asset Transactions: When Howey Met Gary (Plastic), Speech by William Hinman, Director of Division of Corporation Finance
- How we Howey, Speech by Commissioner Hester Peirce
- Framework for “Investment Contract” Analysis of Digital Assets
RS: If a business model is a security, what are the first steps the business should take with the SEC?
HP: I would absolutely encourage everyone working on something to come into the SEC as soon as possible in the process and specifically reach out to the FinHub, which you can find on the SEC website. You can meet with us in person or you can meet with us by phone. For people interested in keeping me in the loop, And just get a sense from our staff what types of things to think about, like the first question you raised in terms of where you fall, security or non-security. They will not give you legal advice but they will give you things that you really ought to think about as you are trying to figure out which side of that line you are on and therefore how you can go about doing your token offering.
RS: There is not much mention about STOs (Security Token Offerings) on the SEC website. Do you think that investors are any better protected with an STO than an ICO?
HP: I look at each offering on a case by case basis, so it’s really difficult to make blanket statements like that. I think people need to be looking at where things fall, if it is a security, figure out whether you want to do it as a registered offering or whether you want to use an exemption, and figure out where it falls best in terms of which exemption to use. It’s hard for me to say categorically that STOs are better than ICOs or vice a versa, again we take a facts and circumstances based approach; we see every offering to be dealt with on its own merits.
RS: Should investors be equally cautious with STOs as they are with ICOs?
HP: In this situation as in every other situation, I tell people who are buying things to ask the right questions, if you’re putting a lot of your money at stake in something you better ask a lot of questions, no matter whether it is a new car, or buying a token, or buying a stock or bond, you need to ask questions. If you can’t get the answer that you think you should get, and if you are not getting answers to questions that are reasonable questions to ask then you probably do not want to invest. There are some basic red flags that apply across any purchase or investment no matter whether it is a digital asset or a traditional security.
RS: Right around this time last year you said “we might be able to draw clearer lines once we see more blockchain projects mature”. How do you think blockchain projects have matured in the past year? Is this more/less maturity than you expected?
HP: I think there has definitely been a maturing, it is encouraging, and I like to see that people are becoming more discerning. People are asking more questions than they were a year or two years ago. I think that holding projects to a higher standard has been good for everyone. I do think that we would see more maturity if the securities law framework were more clear than it is. It’s a bit of a chicken and egg problem, you can’t see as much development without regulatory clarity, and you can’t see the regulatory clarity without knowing what it is you’re providing clarity for. I am hopeful that we will see some more development in the coming year, maybe a lot of that will happen outside the USA, but it may help us think about what the regulatory framework should look like.
RS: I know Malta is doing a lot of progressive regulation for blockchain and digital assets, I think that that is helping guide people in a better direction.
HP: We see other jurisdictions, Malta, Switzerland, and some other jurisdictions that are taking a forward-thinking approach. I think we can learn from what they are doing. I would like for us to be more on the forefront, but it is not bad that other people are thinking about this and we can learn from them – regulators can crowdsource too!
RS: You have been pretty vocal about the SEC taking a watch-and-see approach with ICOs and digital assets. Many people in the ICO/digital asset industry wish that the SEC would regulate quickly so they do not need to operate in a grey zone. What would you tell those people?
HP: I would tell them that I have an idea for a safe harbor. I would hope that people can take a look at that. There are many issues in the United States where there is lack of clarity, this only deals with one of those issues. I hope that people get back to me and give me feed back on that and we can develop something that is workable
Readers can see Commissioner Peirce’s Safe Harbor Speech and Proposal here. The Safe Harbor Proposal details five conditions that teams must satisfy to be able to take advantage of a time limited exemption from federal securities law provisions:
“First, the 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. Second, the team would have to disclose key information on a freely accessible public website. Third, the token must be offered and sold for the purpose of facilitating access to, participation on, or the development of the network. Fourth, the team would have to undertake good faith and reasonable efforts to create liquidity for users. Finally, the team would have to file a notice of reliance.”
The Safe Harbor Proposal is a work in progress and Commissioner Peirce welcomes additional input.
RS: Last month, the SEC filed a proposed rule to amend the definition of “accredited investor”. Can you tell us a little bit more about these proposed changes and how you think they can benefit the digital asset and ICO industry?
HP: The changes really are focused on the institutional category rather than the individual accredited investor category. When we talk about accredited investors, I hear feedback about how frustrated people are that we are essentially judging financial sophistication by one metric, and that is by how wealthy you are. So there are a lot of people who have told me that they would like to see the individual class of what an accredited investor is expanded to people who have demonstrated their financial sophistication in other ways. It is open for comments and people can weigh in on that and if people do not weigh in on that, most on the proposed changes will be on the entity side.
RS: Can the general public weigh in on the proposed accredited investor changes?
HP: You can just send an email, it’s a relatively painless process. It does go up on the website so everyone will be able to see it. We certainly welcome feedback and it is especially nice to hear from people who might not have known that they could submit comments. We are always eager for our proposals to reach more and more people.
For more information about the proposed changes to amend the definition of “accredited investor” :
- Proposed Rule to Amend the “Accredited Investor” Definition
- Press Release – SEC Proposes to Update Accredited Investor Definition to Increase Access to Investments
The deadline for providing feedback to the proposed accredited investor definition is March 16, 2020. Feedback can be sent to email@example.com, noting File Number S7-25-19 in the subject line, or at the comment form here, and click on “Submit comments on S7-25-19” under release number 33-10734.
RS: Currently, companies can legally raise up to $1.07M through crowdfunding, in today’s environment this is not much start-up capital for industries like technology. Above $1.07M companies do not have many cost-conscious options for raising capital legally; the requirements for a company to have an IPO are enormous and bear an equally enormous cost. Some people have been using ICOs/STOs/IEOs as a bridge to solve this gap. What are your thoughts on this?
HP: I would agree that crowdfunding has not achieved the potential that it could achieve, and that’s something that now that it’s been in place for a little while we need to take a look at and see whether we need to adjust how it works and what those adjustments should be. One of the things that we have at the SEC that has been useful is a Small Business Capital Formation Advisory Committee that meets periodically, it’s a group of people outside of the SEC who are involved in capital raising for small businesses. They provide us input on existing rules and how they need to be modified so that they are more workable or on the need for potential new exemptions for people who are trying to raise money. Through that forum we have had some chances to think about crowdfunding and how we can make that work better. I do think people are trying to be creative in thinking about how they can raise money, so I suspect that you are right, some people are viewing token offerings as an alternative to something like crowdfunding. If they are doing that, they better seriously consider how the securities laws apply to what they are doing.
RS: There has been an uptick in IEOs (Initial Exchange Offerings) in the past six months or so; I noticed that the SEC issued an Investor Alert about IEOs recently which is helpful for investors who might not quite realize what is going on with some IEOs. I know some IEOs are trying to make the projects sound more official than they are.
HP: Yes, people like to do that. One of my constant mantras is that I want the SEC to be more open to letting people raise money and invest in projects. But I also want people to know, as a counterpart to that, the SEC does not sign off on investments. So, when you invest in something it is on you, the investor, to make a decision whether that is a good investment at all, and whether it is a good investment for you specifically. Do not assume that things have been pre-cleared or signed off on by the SEC no matter how official something looks.
RS: This is great advice for a lot of new investors that this industry has attracted.
RS: The New York Stock Exchange existed and operated for over 100 years before the Securities and Exchange Commission was established. If the public was able to successfully trade stocks on unregulated exchanges for such a long time, do you think that it is possible that people can self-regulate the ICO industry successfully until there is proper regulation from the SEC?
HP: There are lots of different ways to regulate. We in the US have chosen to regulate our securities market with a mix of self-regulation, government regulation, and quasi-government regulation. One point that I have made in this space, that sometimes gets lost on government regulators like me is that some regulation occurs naturally: markets regulate and discipline themselves. I think the securities industry is one in which we have seen that some versions of self-regulation that can be quite effective. That said, we have a framework that does involve a government regulator (SEC), to the extent that people are engaging in activity that falls within our purview we are the regulator that writes the rules so there should be interaction between what’s going on in that space and us. You can’t just do things that fall within our jurisdiction and say “well I am self-regulating so that’s an acceptable alternative”.
RS: And it comes back around to you saying earlier, contact the SEC, and the SEC can help guide people where to look.
RS: I’ve noticed over the past couple of years a pretty dramatic difference in the digital asset landscape: people are self-regulating, businesses are more professional, and people are asking better questions. I know many people would like SEC regulation so that they can easily follow the law.
HP: I understand that too. I think we are trying to come to a place where we can make it easier for people who are trying to do the right thing to do it in a way that is compliant with our rules that also achieves their objectives, that’s the place that I want to get to. It will never be particularly simple because our securities laws can be really difficult, but we can certainly make it easier than it is now.
RS: Do you foresee the regulations becoming easier for people to follow in the next year or two?
HP: I remain hopeful which is why we want to get the safe harbor draft idea out there so that we can get people thinking about it. One piece of the US regulatory infrastructure that makes nothing simple is that we have so many different regulators who have a potential interest in this space. So even if we do something at the SEC there are other regulators that may also have something to say. There is cross-government cooperation but I think we are going to hear even more calls for there to be even better and closer cooperation.
RS: Is there anything else that we did not touch on that you would like to share?
HP: No, I think you covered it well. You are right to focus on this question of where do things fall with respect to our securities laws and how can we work on adjusting those securities laws so that they help to make it clear to potential people who are interested in getting involved in the space. When a project is really seeking to do something legitimate with the funds and when they are seeing to do something not legitimate with the funds, trying to make a clear path for folks who are trying to do the right thing and I think will serve all of us well.
Below are some additional useful links:
- You can check the SEC database to see if a company you’re thinking about investing in has filed notices such as Form D, Form 1-A, Form C
- One stop shop for SEC news on ICOs and digital assets
- Investor Alerts
- FinHub, the main point of contact for innovators, developers, entrepreneurs to engage with the SEC
- SEC Spotlight on ICOs – for investors and market professionals