The Return of the Token Secure Harbor | Latham & Watkins LLP

    SEC Commissioner Peirce has revived and refreshed her proposed three-year secure harbor for qualifying token initiatives, however some unresolved ambiguities stay.

    US Securities and Alternate Fee (SEC) Commissioner Hester Peirce, a longtime and vocal advocate for innovation in monetary providers, has not shied away from partaking with and supporting the fledgling digital asset ecosystem. One of many milestones alongside this path has been the disclosing of her Token Secure Harbor Proposal on February 6, 2020, in a speech on the Worldwide Blockchain Congress. (See Taking the Scarlet Out of the Letters I-C-O.) Now, following up on a promise to refresh the proposal in mild of suggestions acquired previously 12 months from “the crypto neighborhood, securities attorneys, and members of the general public,” Commissioner Peirce has revealed Token Secure Harbor Proposal 2.0 (Proposal 2.0).

    The unique Secure Harbor Proposal, in addition to Proposal 2.0, present a time-limited exemption for token-based initiatives that search to boost capital to develop decentralized networks. Proposal 2.0 would additionally permit fledgling networks to function unburdened by the onerous registration provisions of the US federal securities legal guidelines till they reached community maturity (outlined as both decentralization or token performance). Supplied that sure requirements and disclosure necessities are met, a three-year grace interval can be granted to permit token builders to pursue “adequate” decentralization of their community from the time of the primary token sale. Because of this, purchasers of the token would now not moderately anticipate that that token worth was being pushed by an individual or group by way of managerial or entrepreneurial efforts.

    What’s New in Proposal 2.0

    In line with Commissioner Peirce, Proposal 2.0 “just isn’t a bright-line check, however relatively makes an attempt to strike a steadiness between offering a manageable variety of helpful guideposts whereas sustaining adequate flexibility for the info and circumstances of every community to be thought of within the evaluation.”

    Proposal 2.0 updates the unique Secure Harbor Proposal in a number of key respects, together with the next:

    • Firms should present updates to the SEC each six months (till the top of the three-year interval, or a dedication that community maturity has been reached) on the required “plan of growth” disclosure. This disclosure is outlined as the present state and timeline for the event of the community to point out how and when the preliminary growth group intends to attain community maturity.
    • Community maturity continues to be outlined binarily as both performance or decentralization; nonetheless:
      • Decentralization now requires that the preliminary growth group should not personal greater than 20% of the related community’s tokens, or personal greater than 20% of the technique of figuring out community consensus.
      • Performance is “demonstrated by the holders’ use of Tokens for the transmission and storage of worth on the community, the participation in an software operating on the community, or in any other case in a way in keeping with the utility of the community.”
    • Disclosure necessities on a freely accessible public web site now embrace:
      • A hyperlink to a block explorer, a web-based device that permits a person to seek for data on a blockchain (for extra data, see Latham’s E-book of Jargon® — Cryptocurrency & Blockchain Know-how)
      • An outline of any materials transaction, or any proposed materials transaction, wherein the preliminary growth group is a participant and wherein any associated particular person had or could have a direct or oblique materials curiosity
      • A press release that the acquisition of tokens entails a excessive diploma of danger and potential monetary loss
    • An exit report requirement now requires growth groups to have interaction outdoors counsel on the finish of the three-year grace interval to research whether or not their community has reached maturity. The evaluation should describe the extent to which performance or decentralization has been reached throughout quite a few dimensions.
    • The evaluation should present an outline of the extent to which decentralization has been reached throughout quite a few dimensions, together with voting energy, growth efforts, and community participation. If relevant, the outline ought to embrace:
      1. Examples of fabric engagement on community growth and governance issues by events unaffiliated with the preliminary growth group
      2. Explanations of quantitative measurements of decentralization
    • The evaluation should present an evidence of how the preliminary growth group’s pre-network maturity actions are distinguishable from its ongoing involvement with the community. The reason ought to:
      1. Focus on the extent to which the preliminary growth group’s persevering with actions are extra restricted in nature and can’t moderately be anticipated uniquely to drive a rise within the worth of the tokens
      2. Affirm that the preliminary growth group has no materials details about the community that isn’t publicly obtainable
    • Describe the steps taken to speak to the community the character and scope of the preliminary growth group’s persevering with actions
      • If community maturity has not been attained, the exit report should comprise a press release that the preliminary growth group will file a Type 10 to register the tokens as a category of securities inside 120 days of the submitting of the exit report, beneath Part 12(g) of the Securities Alternate Act of 1934.
      • The exit report have to be filed electronically with the SEC by way of the web EDGAR platform in accordance with Regulation S-T.
    • A brand new grace interval for buying and selling platforms will exempt such platforms from the necessities of Part 6 of the Alternate Act attributable to exercise associated to the buying and selling of tokens involving networks that haven’t reached maturity. This grace interval will probably be granted on the situation that the buying and selling platform prohibits such buying and selling inside six months of such dedication.
    • Proposal 2.0 deletes a good-faith provision, whereby growth groups had been anticipated to “undertake good religion and affordable efforts” to attain community maturity inside three years of the date of the primary sale of tokens and create liquidity for customers.
    • Proposal 2.0 deletes a provision whereby if growth groups try to safe secondary buying and selling of the token on a buying and selling platform, the event group would “search secondary buying and selling platforms that may display compliance with all relevant federal and state legislation and laws referring to cash transmission, anti-money laundering, and client safety.”

    Progress, however Unresolved Ambiguities Linger

    Proposal 2.0 represents a big step ahead for the digital asset business and would offer token holders with higher safety and transparency. It additionally gives helpful perception into how Commissioner Peirce believes decentralized networks ought to function, together with how growth groups ought to reduce or change their contributions and the way initiatives ought to work together with their communities. However regardless of these admirable enhancements, Proposal 2.0 doesn’t bridge among the essential points that outlined the unique proposal.

    Particularly, Proposal 2.0 doesn’t create a bright-line check for “community maturity” whereby tokens on such networks won’t be deemed securities (that is acknowledged by Commissioner Peirce in her assertion). Though “decentralization” is extra fleshed out than within the earlier model (significantly the 20% thresholds famous above), legislation corporations will nonetheless be challenged to ship opinions with such scant steerage concerning the weighting of the varied components. Even with the evaluation and attestation of competent outdoors counsel utilizing the supplied guideposts, the specter of enforcement will proceed to loom the place info and circumstances aren’t framed by a bright-line commonplace. That specter is encapsulated within the disclaimer carried over into Proposal 2.0: “The definition of Community Maturity is meant to offer readability as to when a Token transaction ought to now not be thought of a safety transaction however the evaluation with respect to any specific community would require an analysis of the actual info and circumstances” (this italicized textual content is new in Proposal 2.0).

    As well as, the practical prong of the binary “community maturity” definition seems to be a gap that might subsume the decentralization prong. That’s, if builders can keep away from the securities legal guidelines by controlling a totally functioning mission, why would they search decentralization? Whereas performance is a obligatory element of beating the Howey check, it’s not clear why performance alone — with out decentralization — can be adequate to protect a mission from federal securities legal guidelines if the general success of the mission continues to depend on a government. A safety token that’s used for transmission and storage of worth on a practical community, for instance, would paradoxically seem to qualify for community maturity and the safety of the secure harbor even whether it is managed by a government whose efforts to advertise and proceed to take care of the mission are very important to its success and the worth of the token. However, many governance tokens that present holders with practical rights with respect to the governance of decentralized networks would fulfill each prongs of the secure harbor, and subsequently should be supported with the proposed regulatory certainty.

    Lastly, whereas Proposal 2.0 does a lot to align the pursuits of token holders and growth groups, it might depart token holders and growth groups uncovered to important danger of financial hurt, as a result of it fails to deal with or search to restrict speculative buying and selling of centralized mission tokens on secondary markets. A possible treatment for this could possibly be the addition of transferability restrictions correlated with the decentralization progress achieved by the mission.

    Commissioner Peirce continues to hunt crowdsourced suggestions, and to that finish, posted Proposal 2.0 on an web platform the place tech builders can entry open supply software program and collaborate on initiatives, the exact same platform on which open supply code lives for many token initiatives.

    A Altering of the Guard on the SEC

    Proposal 2.0 was launched the day earlier than Gary Gensler was confirmed by the Senate as the brand new chairman of the SEC. Chairman Gensler is extensively anticipated to be attentive to the digital asset business’s requires regulatory progress on this house. In actual fact, throughout his Senate affirmation listening to, he informed Congress that he would pursue new laws for cryptocurrencies, which he described as a “catalyst for change.” Whereas his method will certainly be underpinned by the SEC’s deal with investor safety, the business would profit from a well-defined framework. The business is hopeful that Commissioner Peirce’s assist, together with Chairman Gensler’s recent perspective and mandate, will lead to a breakout from the regulatory holding sample.

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