The SEC would still be watching under Peirce's safe harbor proposal – and they'd know where to look

Securities Exchange Commission commissioner (SEC) Hester Peirce put a rule proposal on the table at the close of last week that would give growing decentralized networks a three year-grace period before their respective token is put to the test of U.S. securities law.

While many are celebrating the move to relax scrutiny on budding projects that provide disclosure – which, supporters say, would allow the ecosystem to flourish without the specter of an SEC reprimand – the rule would give the SEC a closer look at developing token projects.

Assessing the impact

Commissioner Peirce’s proposal has been seen as a gesture of good faith towards the crypto industry, acknowledging that lack of clarity on where tokens intended for use in decentralized networks fit in the web of securities laws. 

“It is important to write rules that well-intentioned people can follow,” she said at Chicago’s International Blockchain Congress event. “When we see people struggling to find a way both to comply with the law and accomplish their laudable objectives, we need to ask ourselves whether the law should change to enable them to pursue their efforts in confidence that they are doing so legally.”

Even though it just debuted, Peirce's effort is already having a tangible impact.

Telegram’s counsel filed the speech and proposal ahead of the next hearing in its ongoing legal dispute with the SEC, giving judicial notice to Hon. P. Kevin Castel. It could show there is uncertainty over the application of securities laws in the case of token use in growing networks.

Still, it’s important to note that the proposed rule is just that – a proposal – meaning that the statement comes from Commissioner Peirce herself rather than the SEC as a whole – and though Telegram may use it to demonstrate uncertainty, it’s not a rule that can be applied. 

In the meantime, Peirce is looking for feedback, and her introductory speech pointed to a few places that she said need fine-tuning, including certain definitions. 

In this current form, the safe harbor period would last for three years, affording companies time to sufficiently decentralize their networks before being beholden to securities definitions.

While some have said three years is sufficient and others cry too short or too long, Joshua Ashley Klayman, U.S. head of fintech and head of blockchain and digital assets at the law firm Linklaters, said the period isn’t just for companies to catch up to policy, but for policymakers to take a closer look at crypto.

“If you think about three years ago, we didn't even have the DAO guidance,” said Klayman. “So not only does the three-year window give time for developers to get their projects developed sufficiently, a sufficiently centralized week, it actually gives a lot of breathing room for the determination of whether something is sufficiently decentralized.”

Focus on disclosure

The rule proposal came with a list of disclosure requirements for those intending to claim safe harbor.

In fact, most of the requirements to apply for the three-year safe harbor hinge on disclosures, rather than the strength of a particular project. This is because securities laws in the U.S. aren’t merit-based, meaning investor risk takes a back seat to disclosure, according to Georgia Quinn, chief counsel for CoinList.

“It's really the hallmark of the SEC and securities laws,” she said. “The way that the securities laws work in the United States is that we don't ban assets. We don't tell people this is a good investment or this is a bad investment. What we do is we require disclosure about it to let people make informed decisions.”

Consumer protections

However, some consumer protections are still baked in. The clause that assets must be traded on a regulated exchange creates liquidity for the consumer, according to Quinn. This allows a holder to easily liquidate a position rather than taking meandering legal routes to drop support of a project.

“The requirement that these assets need to be traded on a regulated exchange also is huge consumer protection because basically adequate disclosure coupled with liquidity is the best consumer protection you could ever have because it allows people to know what's going on and if they don't like it, they can sell it,” said Quinn.

In some ways, these disclosures outweigh the disclosure requirements in traditional finance. These include the plan of development, prior sales, information on the development team, economics and governance of the token, transaction history of the network and the source code of the project among other things. Quinn said source code disclosure does more than show the SEC that a project is composed of well-intentioned actors – it’s an objective layer of transparency.

“That's kind of different than when you think about like a public company and what they have to disclose, because the code doesn't require judgment,” she said. “It can't be fabricated. The code is the code, and someone can test that on their machine and they can tell you if it does what it claims to do.”

Big Brother is watching – and listening

Although at first glance the safe harbor proposal may look like a three-year grace period to work without fear of an SEC crackdown, it also helps regulators to keep a more watchful eye on the space itself.

Quinn pointed out that as many of these token projects take root, such a rule would have them registering in some capacity with the SEC. 

Right now, projects launch without the SEC knowing where to look or having a sense of who is doing what. By applying for a safe harbor, the disclosure requirements put each project on the radar – thus allowing the SEC to monitor on a burgeoning industry.

But it also shows that the SEC – or at least parts of it – are intent on doing more than watching.

As Klayman pointed out, they’re listening. Peirce has made her email address publicly available in order to solicit feedback from any stakeholder. Her speech made it clear that her ideas are not yet fully formed and she’s still looking for varying opinions that may alter her proposal going forward. Klayman said regardless of how the rule proposal moves forward, this is a great sign for the industry.

“I think we are so lucky to have regulators who are really listening,” she said. “You can look at the token safe harbor proposal and say, ‘this person has clearly had discussions with people in the industry.’”