SEC Commissioner Hester M. Peirce cautioned against the "blanket" classification of digital tokens used in initial coin offerings ("ICOs") as securities, and warned against the overregulation of ICOs, tokens, distributed ledger and other crypto technologies. In a recent speech to the Medici Conference in Los Angeles, she advocated for greater communication between crypto industry leaders, the SEC's Division of Corporation Finance and other regulators in order to continue to vigorously shut down fraudulent transactions without overreacting and preventing new technologies from having a chance to succeed.
Commissioner Peirce explained that the evolving functionality of digital coins and tokens makes their classification unclear. An ICO that "involves the sale of tokens to investors seeking to realize a profit from the increased value of their coins once the environment is created" may constitute a securities offering, she said. In these and similar circumstances the ICO tokens would fall under SEC jurisdiction and be subject to registration under Section 5 of the Securities Act of 1933.
Commissioner Peirce urged regulators to devise a structure for handling ICOs and tokens that may fall under SEC jurisdiction, including (i) thoroughly assessing and then applying the "Howey Test" ( SEC v. W.J. Howey Co.) to properly understand the tokens; (ii) maintaining an open relationship with industry participants to avoid "bad regulation"; and (iii) avoiding micromanagement of the development of new technologies by industry participants. She also cautioned against regulation via enforcement, noting it was unfortunate that, to date, most communications from the SEC on the topic of ICOs have emanated from the Enforcement Division.
Commissioner Peirce also pushed back against the "regulatory sandbox" approach of ICO regulation that is intended to allow businesses to test innovative products, services, business models and delivery mechanisms in the real market, with real consumers. Instead, Commissioner Peirce suggested, regulators should consider the metaphor of a beach lifeguard who is "watch[ing] over what is happening, but [] is not sitting with sandcastle builders monitoring their every design decision." While "sandboxes" have proven successful in certain instances, Commissioner Peirce warned of the danger of overregulating the crypto industry out of business, and suggested that regulators keep a watchful eye while permitting the industry to flourish (or fail) on its own.
Commentary / Joseph V. Moreno
SEC Commissioner Peirce demonstrates a degree of open-mindedness on cryptocurrency that is hopefully shared by her fellow Commissioners. Her much-needed input is a shot in the arm for ICOs and an industry struggling to apply traditional securities rules to technologies and products that are anything but traditional. Commissioner Peirce holds out hope that ICOs and other crypto technologies will be governed not through reactive enforcement action but well-reasoned regulation that is implemented with industry input. She makes clear that cryptocurrencies such as bitcoin are not themselves securities, and that tokens or coins used in ICOs may be securities depending on the facts and circumstances of each offering. She also notes that ICOs may (or may not) qualify as private placements under Regulation D or another registration exemption.
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