As has been widely reported, SEC Commissioner Hester Peirce (aka “Crypto Mom”) recently delivered a thoughtful speech entitled “Running on Empty: A Proposal to Fill the Gap Between Regulation and Decentralization,” including with it a model rule on digital token sales. The model rule has made waves in the crypto community because it proposes a three-year safe harbor from SEC registration while a development team builds out a functional, decentralized network.
The basic premise of the model rule is that the SEC’s Howey test should be easier to pass at the end of three years than when a decentralized network is first launched. In Commissioner Peirce’s view, once a network cannot be controlled or unilaterally changed by any single person, entity, or group of persons or entities under common control, the token that operates on that network will not look like a security.
Accordingly, upon conclusion of the three-year period, the model rule provides that the development team would be required to determine whether token transactions involve the offer or sale of a security. Token transactions would not constitute securities transactions if “Network Maturity” is achieved, in which case no further SEC registration is required.
Under the model rule, Network Maturity of a network is achieved when the network is either:
- not controlled and is not reasonably likely to be controlled or unilaterally changed by any single person, entity, or group of persons or entities under common control; or
- functional, as demonstrated by the ability of holders to use tokens for the transmission and storage of value, to prove control over the tokens, to participate in an application running on the network, or in a manner consistent with the utility of the network.
In exchange for the three-year glide path, token developers would still be required to provide a variety of disclosures to investors, including information about technical specifications, token economics, background of the development team, the plan of development and other material facts. During the three-year period, the model rule also provides exemptions from broker-dealer and exchange registration as well as other technical exemptions from the federal securities laws.
Commissioner Peirce is to be applauded for her creative, non-conventional approach to the issue of token registration at the SEC. She has been a frequent critic of the SEC’s complicated, form-over-substance approach to categorizing most digital assets as securities and has urged a certain measure of regulatory humility for the agency along the way.
Of course, the model rule remains a thought piece, albeit a provocative one, and it would require formal action by the other SEC commissioners to propose an actual SEC rule for public comment. At this time, the prospects for further formal action seem dim. Still, Commissioner’s speech and model rule have further advanced the debate on the SEC’s proper role in the regulation of crypto assets more generally, and the growing amount of public commentary on the model rule will be difficult for policymakers to ignore in the future.