The Clarity for Digital Tokens Act of 2021 would give token issuers the guardrails they need to innovate with far less regulatory anxiety.
By Stephen P. Wink and Deric Behar
US Securities and Exchange Commission (SEC) Commissioner Hester Peirce has always been something of a maverick. She has been a lone dissenting voice on the Commission on many topics, applying her libertarian leanings to question the need for regulations that could hobble free markets or stifle innovation.
Those who follow the digital assets markets also know Commissioner Peirce by her nickname “Crypto Mom,” for her relentless support of digital asset innovation and calls for clear regulatory guidance when she perceives they are lacking. To remedy some of those issues, Commissioner Peirce published a Token Safe Harbor Proposal on February 6, 2020, and reissued a revised version (Proposal 2.0) on April 13, 2021 (previously discussed in this post).
Proposal 2.0 never quite gained traction at the SEC, but it has found an ally in Congress. On October 5, 2021, Representative Patrick McHenry, the ranking member on the House Financial Services Committee, introduced a bill titled the Clarity for Digital Tokens Act of 2021 (the Bill) that substantially embodies Commissioner Peirce’s Token Safe Harbor Proposal 2.0.
SEC Chairman Gary Gensler has maintained that the securities laws are “quite clear” with regard to digital assets, but others disagree and persistently call for legal clarity and regulatory certainty for the industry. The Bill would amend the Securities Act of 1933 (and related definitions in the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940) to provide “a novel regulatory sandbox concept” that would promote, rather than hinder, digital asset innovation.
Representative McHenry acknowledged in a statement that the Bill was built on the work of Commissioner Peirce and would offer market participants the same safe harbor as Proposal 2.0. Indeed, the Bill replicates Proposal 2.0 with just a handful of de minimis variations.
Like Proposal 2.0, the Bill would provide a time-limited exemption for token-based projects that seek to raise capital to develop decentralized networks. It would also allow fledgling networks to operate unburdened by the onerous registration provisions of the US federal securities laws until they reached network maturity (defined as either decentralization or token functionality). Provided that certain factors, disclosures, and exit reporting requirements are met, a three-year grace period would be granted to allow token developers to pursue “sufficient” decentralization of their network from the time of the first token sale. Following that grace period, purchasers of tokens would no longer reasonably expect that a person or group was driving that token’s value via managerial or entrepreneurial efforts, and therefore the tokens would not be considered securities (or investment contracts) under the Howey test.
It appears that no substantial amendments were incorporated into the Bill from Proposal 2.0, notwithstanding Commissioner Peirce’s call for (and receipt of) crowdsourced feedback. The Bill, therefore, reflects the shortcomings and unresolved ambiguities that shadowed Proposal 2.0. Namely, like Proposal 2.0, the Bill defines “network maturity” as either functionality or decentralization. While the Bill provides “useful guideposts” (Commissioner Peirce’s phrase in the introductory remarks to Proposal 2.0), it does not set out a bright-line test that would provide any guarantees of network maturity. Commissioner Peirce was candid with this ambiguity in Proposal 2.0 when she stated in her preliminary notes that “the analysis with respect to any particular network will require an evaluation of the particular facts and circumstances.” The Bill eschews such commentary, but the specter inherent in a facts-and-circumstances analysis remains.
As in Proposal 2.0, the Bill does not justify why functionality alone — without decentralization — would be sufficient to shield a project from federal securities laws if the overall success of the project continues to rely on a central authority (even if the exit report attests that the initial development team’s efforts will thereafter “be focused on the token’s consumptive use, and not on token price appreciation”).
While Proposal 2.0 required that the exit report describing the achievement (or non-achievement) of network maturity be provided specifically by “outside counsel,” the Bill was very subtly amended to require only “a legal analysis” — allowing, perhaps, for a less stringent standard for the authors of the exit report to demonstrate network maturity.
The Bill is not the first crypto-related proposal in Congress (see this post for details on Representative Don Beyer’s recent effort), but market participants have lauded it as a huge step for the industry, and one that has the potential to introduce regulatory certainty to the space and promote domestic innovation. According to Representative McHenry, “[t]his legislation ensures our regulatory framework embraces new technology and innovation by providing a ‘safe harbor’ for startup digital asset projects, while maintaining important investor protections.” Whether the Bill is enacted into law remains to be seen. In the meantime, industry participants and digital asset enthusiasts can cheer this important appearance of crypto on Capitol Hill.
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