Proposal for Opening to ICOs by the SEC
By Raffaella Aghemo on The Capital
It would seem plausible, in the United States, that the Securities and Exchange Commission or SEC could move towards greater openness to the ICO phenomenon, and let us see how.
On February 6, Hester Peirce, SEC Commissioner, presented a proposal for a new regulatory framework to be applied to the Initial Coin Offering phenomenon. It seems to me evocative that it is a woman who is the spokesperson for the appropriate need to embark on a path of change. In her speech, she begins by recounting an episode in her personal life twenty years earlier: she was on the road, under a heavy storm, without a mobile phone, who knows where, when she realized that the gas tank of her car was empty. The first natural reaction was panic, followed by the discovery that she was in the State of New Jersey and the feeling of comfort of seeing a petrol and gas pump in the distance. In that instant, she realized she was in the territory of New Jersey, where there was a singular law forbidding anyone who was not a gas station attendant to fill up with gas! No one else was allowed to refuel gas independently! «I looked forward to the gas station attendant, awakened from a comfortable sleep when I arrived, coming out of his cabin and starting the pump. He looked at me. I looked at him. He pointed at me. He pointed to the pump. His message was clear: forget the law, there would be no full service on that dark and stormy night.» Without revealing his choice of that night, the commissioner explained that this episode taught her an important lesson, which she quoted in these words: «It is important to write rules that well-intentioned people can follow. When we see people struggling to find a way both to respect the law and to achieve their laudable goals, we must ask ourselves whether the law must change so that they can continue their efforts with the confidence that they are acting legally». Therefore, «today I will focus on how to address the regulatory challenges faced by people who want to build functioning token networks.»
Until now, the SEC has always treated most tokens as investment contracts and stock offers according to the Howey Test. Peirce, in this meeting, proposes instead to treat some tokens, not as securities, but to grant their sale to investors not accredited in the United States, provided that the disclosure and other requirements set out in a “safe harbor” discipline are met. In the previous “Framework”, the SEC had indeed analyzed cases in which tokens, if at the time of issue, could be considered securities, then, when the network had become decentralized, they could change “nature”. These cases raised doubts, which the SEC proposed to resolve, by changing the SEC’s previous totalitarian view of all tokens as securities and therefore subject to sales and trading restrictions imposed by laws and regulations that limit their use in a decentralized manner.
Therefore, the Commissioner proposes a so-called “grace period” of three years to create a safe harbour, within which the decentralized network could be formed. Such a “network maturity” would take place under certain conditions, which would materialize when the network is established:
- is not controlled, it is not reasonably likely to be controlled or modified unilaterally by a single person, entity or group of persons or entities under common control;
- it is functional, as demonstrated by the owners’ ability to use tokens for transmission and storage of value, to demonstrate control over tokens, to participate in an application running on the network or in a manner consistent with its usefulness.
It would then be up to the development team to act in good faith and transparency to implement secondary trading on trading platforms, which although previously ostracized by SEC regulations, becomes indispensable to create liquidity for the benefit of users and developers.
Transparency should be ensured by disclosure of all ordinary and extraordinary information, such as source code, token economics, i.e., their offering, generation, distribution and governance; the network development plan; the development team, their experience, and token previews; trading platforms for tokens to the known extent; and notices of sales of more than 5% of tokens initially held by members of the initial development team, all within fifteen days of the initial sale of tokens: “The final condition is that the team must submit a notice of reliance on EDGAR, within fifteen days of the date of the initial sale of tokens, relying on the safe harbor. (Editor’s note: The EDGAR database provides free public access to corporate information, allowing the search of information and financial transactions of a public company by examining documents filed by the company with the SEC. It is also possible to search for information provided by mutual funds, exchange-traded funds, and variable annuities).
As she rightly pointed out in her speech, «I think there is a way to address the uncertainty of the application of securities laws to tokens. The safe haven I am proposing this morning recognizes the need to achieve the investor protection objectives of securities laws, as well as the need to provide the regulatory flexibility that allows innovation to flourish.»
If you would like to read, and I highly recommend it, the Commissioner’s entire speech, here is the link: https://www.sec.gov/news/speech/peirce-remarks-blockress-2020-02-06.
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Raffaella Aghemo, Lawyer