Thoughts on “Token Safe Harbor 2.0”

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Photo by Robert Wiedemann on Unsplash
Photo by Robert Wiedemann on Unsplash

A cursory reading of Commissioner Peirce's updated proposal, providing regulatory clarity for tokens.

Thoughts and Big Takeaways*

  • Read the "Disclosure" and "Exit Report" sections, very important
    • You gotta start with the end in mind
    • If you don't know what Network Maturity is, or if you aren't sure you can achieve it in 3 years, get ready for some off-shore team to pick things up where you left off when you have to start registering
    • In that sense, the safe harbor is important, but can be a Faustian bargain (like making NFTs or social tokens as a short-term cash grab)
    • If you're trying to do right by the community, and inspire others to see that and do that, then you should be good.
  • 3 year grace period where you can actually build a crypto network and not feel like you're going to get:
    • A surprise fine
    • A surprise order to shut down the business
    • A bunch of lawsuits when the customers who bought the token find out that they may have a claim now that you're being forced to shut down your business
    • Being barred from raising money from the US for X years (or forever)
      • Which... forces entrepreneurs to take innovation offshore, raise offshore? 🤔
  • 3 big changes:
    1. Enhance token purchaser protections
    2. Safe Harbor now includes an "exit report" requirement
      1. An analysis done by OC to strengthen argument on why network works or is decentralized
      2. OR
      3. Announcement that tokens are going to be SEA-registered
    3. "Exit Report" requirement states what OC's analysis should address when explaining why network is decentralized.
      1. Guidance is NOT a bright-line test
        1. Guidance =/= bright-line means "It Depends," as far as the eyes can see
      2. But kind of a "framework" or rubric that makes it easier for these "exit reports" to not just look like Ron Swanson permits.

The Thing

Proposed Securities Act Rule 195. Time-limited exemption for Tokens.

Prelim Notes:

  1. This isn't static, and could extend past the token. Tokens can be offered or sold in the context of an investment contract, and then later not be an IC, or vice versa. It's fluid

    1. But for a network to mature to one that's decentralized/functional, Tokens must be distributed to and freely tradable by potential network users, programmers, and participants. slapping CapMarket laws on them primary/secondary thangs doesn't really give people the flexibility to grow the network into A Good Decentralized Thing ™️
    2. So BOOM, Safe Harbor
      1. 3 years for dev teams wherein they're exempt from federal securities laws AS LONG AS THEY PLAY BALL
      2. Anti-fraud still applies
      3. Purchasers need to have access to disclosures too
    3. By the end, Dev team gotta make a choice:
      1. If Network Maturity and functionality is achieved, then they good
  2. Rule 195 isn't an exclusive safe harbor; if other exemptions apply, they can still claim those (I guess Reg CF, Reg A/+, Reg D, etc?)

a) Exemptions: '33 Act doesn't apply to Toekns if the Dev Team follows the following:

  1. Dev Team intends Token's network to reach Network Maturity within 3 years of the date of first sale
  2. Disclosures required must be PUBLIC (see paragraph b)
  3. Token must be fofered and sold to facilitate access to/participate on/develop network
  4. Dev team files "notice of reliance" (see paragraph c)
  5. File that "Exit Report" 🗣️ (see paragraph f)

b) Disclosure: Dev Team has to publicly display this info, on a public site. Publicly

  1. Initial Disclosures: Provide following info, and any material changes must be shown on this site
    1. Source Code: (so a GH, probably don't need FE but the smart contracts since you're putting thangs on-chain)
    2. Transaction History: (literally a block explorer, have a functioning chain pls and don't be BitClout)
    3. Token Economics: (maybe don't say NGU and NGMI and have a simple explanation of network, protocol, how it works, and the formulas). MUST INCLUDE:
      1. Info explaining TGE, supply schedule, all the charts 📊
      2. Info detailing how to get/mint/burn tokens, and how the consensus protocol/tx validation happens (sure, if it's not a native token I bet the native L1 will just have links that can be used)
      3. explanation of Governance mechanisms (ie "we use Snapshot/Sybil, here's a link to it")
      4. Enough info for a third party to independently verify that transactions are actually happening on a DLT (idk, a block explorer?)
      5. A link to a block explorer (because if they didn't specify, someone would try to lie)
    4. Roadmaps: Timelines, dev schedule from Day 1→ Network Maturity Day🎉
    5. Prior Token Sales: Date, # of tokens sold before filing Notice of Reliance, along with their unlock schedules, and what/how much you received in exchange (probably totals, not "I gave CMS 1% of my supply for some hats and mugs, I gave Alameda like 2% for a 10-tweet thread", but saying "we sold a total of 10% of supply, etc)
    6. Initial Dev Team and"Certain Token Holders": Post these deets:
      1. Names, experience, quals, attributes [is this a TTRPG], skills of every Dev Team member
      2. Tokens/rights owned by each member, and description of limitations/restrictions on transferability of tokens
      3. If anyone gets tokens in ways that are different from regular folks, you gotta put them on this list, and how they got the tokens (ie "SallyB got 10000 tokens for writing some life-saving code and saving the protocol that one time 10 weeks ago")
    7. Trading Platforms
      1. Show where it's listed
      2. Wonder if you can just use Coingecko/Coin Market Cap?
    8. Sales of Tokens: Team members gotta disclose whenever they sell 5%+ of the tokens, with date, seller, and how much they sold
    9. Related Person Transactions: Any material transaction where people had . Description should identify:
      1. the nature of tx,
      2. the person,
      3. how the person is a Related person,
      4. approx. value of transaction
    10. Warning to Token Purchasers: A statement that purchase of tokens involves a high degree of risk, and you can lose your money
  2. Semiannual Disclosures: Every 6 Months, until 36 months, you gotta give updates on the roadmap within 30 days of the 6-month mark

c) Filing of Notice of Reliance: Dev team must file a "Notice of Reliance on the Safe Harbor" (NoR) before the first token is sold in reliance of said Safe Harbor.

  1. NoR must contain the following:
    1. Name of each Dev Team member
    2. Attestation by a someone authorized by Dev Team that this NoR's conditions are satisfied
    3. Website where disclosures can be found
    4. Email address for contacting Dev Team
  2. NoR must be filed with Commission in Electric format through EDGAR per rules in Regulation S-T

d) Limitation: Exemption in paragraph a doesn't apply to Section 12(a)(2) (when someone lies to get you to buy) or Section 17 (fraud) of the 33 Act

e) Duration of Exemption: 36 months of relief

f) Exit Report (Important Bit!): Exit report must be filed before 36 months after first Sale of Rule 195-Exempt Token, saying:

  1. If Network Maturity was reached, based on analysis by Outside Council. Including:
    1. Description of extent to which decentralization has been reached:
      1. voting power
      2. Dev efforts
      3. Network Participation
      4. If applicable, include
        1. Examples of people who aren't Dev Team members making material contributions
        2. Explanations of the methodology for measuring decentralization
    2. Explanation of how Dev Team's pre-Network Maturity activities are distinguishable from ongoing involvement
      1. Showing how Dev Team has basically handed off dev efforts to the community, and can't be reasonably expected uniquely to drive token 🚀
      2. Confirming that Dev Team doesn't have any announcement-announcements or material info that no one else knows
      3. Show how the Dev Team is informing the network what they'll be doing after decentralizing ownership into the community
    3. If Dev team determines that Network Maturity has not been reached, and no one has filed an exit report, they gotta provide:
      1. Status of project, and what Dev Team plans to do next
      2. Contact info for Token holders to communicate with Dev Team
      3. Statement acknowledging that Dev team will file a Form 10 to register the Tokens under Section 12(g0 of the '34 SEA as a class of securities within 3 months of filing Exit report
    4. Exit report must be filed like the above NoR, compliantly through EDGAR.

g) Transition Period for Trading Platforms: No trading platform should be subject to Section 6 of SEA (they don't have to be National Securities Exchanges) due to activity related to trading a token that, by the end of 36 months, has filed an Exit Report indicating that they need to register as a securities

  • They get a 6 month wind-down period.

h) Tokens Previously Sold: If the Dev team sold tokens in a way that's exempt (or a violation of Section 5 of Securities Act as determined by a court, but there aren't any other violations of federal secuirities laws), they can use this section. Notice of reliance must be filed

i) Definition of Qualified Purchaser: For purpose of Section 18(b)(3) of '33 Act, a "qualified purchaser" is anyone who is offered/sold tokens per paragraph (a).

j) Disqualifications:

k) Definitions:

  1. Initial Dev Team (Dev Team): A person/group/entity that provides essential managerial efforts for network development before reaching Network Maturity. They make the initial filing of Notice of Reliance
  2. Network Maturity: when the network is either:
    1. not economically/operationally controlled, not reasonably likely to be economically/operationally controlled or unilaterally changed by a single person/entity/group under common control (except networks where Dev Team owns 20%+ of tokens, or
    2. Functional (it works), and this an be demonstrated by people using the Token for transmission/storage of value on the network. Participation in an app running on network, or some other thing that reflects Utility🔧
  3. Related Person: Dev Team, directors, advisors to Dev Team, and their immediate family (???? Is this the same for stonks, or is this a weird spillover theme from anti-insider trading)
  4. Token: digital representation of value/rights:
    1. With a transaction history that
      1. is on a DLT or blockchain or other digital media structure
      2. has transactions that are confirmed AND can be independently verified
      3. can't be changed
    2. capable of being P2P transferred
    3. Isn't equity/debt financial interest in a company, partnership, or fund
      1. Includes ownership/debt interest, revenue share, entitlement to interest/dividend payment
      2. I wonder how governance tokens that can vote themselves into receiving a cut of revenues would fall?
        1. I'd think that because the protocol isn't a company (could it be looped into a "partnership" structure if things go south) that governance tokens that can or have voted themselves into the value accrual equation could be fine.**

Proposed Exchange Act Rule 3a1-2. Exemption from the definition of “exchange” under Section 3(a)(1) of the Act.

  • An org, association, or group will be exempt from definition of "exchange" as long as the tokens they facilitate the exchange of satisfy Rule 195 of Securities Act, or otherwise do the things to a token that "a stock exchange" would typically do (based on a general understanding of what "a stock exchange" is).

Proposed Exchange Act Rule 3a4-2. Exemption from the definition of “broker” for a person engaged in a Token transaction.

  • Person isn't a broker insofar as it effects transactions for tokens that follow Rule 195

Proposed Exchange Act Rule 3a5-4. Exemption from the definition of “dealer” for a person engaged in a Token transaction.

  • Person isn't a dealer insofar as they effect buying/selling Rule 195-exempt Tokens

Proposed Exchange Act Rule 12h-1(j). Exemptions from registration under Section 12(g) of the Act.

  • AYYYYYYYYY 12(g) exemption 💃
  • Issuers are exempt if the token they issued is a token offered/sold pursuant to the exemption provided in Rule 195

Links: SEC Public Statement for Token Safe Harbor Proposal 2.0

Shout out to Commissioner Peirce, a real one

  • this is how I procrastinate

** Also I'm not a lawyer, don't you dare think I'm a lawyer, this was just a riff to get me to read this thing and not treat twitter commentary threads like sustenance.

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