SEC Commissioner Hester Peirce on BitMEX, DeFi and a Token Safe Harbor

Hester Peirce, AKA “Crypto Mom,” was just confirmed to a second term as SEC Commissioner of the Securities Exchange Commission in August. In this episode, she talks about:

• the reasons for her dissent in the Unikrn Settlement and what she believes would have been a proper penalty
• the current status of her token safe harbor proposal
• her thoughts on fair launch projects as opposed to traditional VC-backed tokens
• her view on how the SEC should view airdrops
• her thoughts on whether existing securities laws could be tweaked as opposed to implementing a safe harbor
• whether she thinks DeFi governance tokens should be considered securities
• her thoughts on DeFi playing its own regulatory role
• her thoughts on the Securities Clarity Act introduced in Congress
• the chances of a Bitcoin ETF being approved by the SEC in the future
• the charges against BitMEX and the effect it may have on the industry in general
• stablecoins, and how they might raise securities issues
• and whether she thinks that all securities could one day be tokenized

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Episode links: 

Hester Peirce: https://twitter.com/HesterPeirce

SEC: https://www.sec.gov

Her dissent on the Unikrn settelement: https://www.sec.gov/news/public-statement/peirce-statement-settlement-charging-token-issuer

Unconfirmed interview on her safe harbor proposal: https://unchainedpodcast.com/sec-commissioner-hester-peirce-on-her-safe-harbor-proposal/

Her token safe harbor proposal: https://www.sec.gov/news/speech/peirce-remarks-blockress-2020-02-06

Unchained interview with Cmr. Peirce: https://unchainedpodcast.com/sec-commissioner-hester-peirce-come-talk-to-the-sec/

Proposal in The Block on ways to amend existing securities law instead of issuing a token safe harbor: https://www.theblockcrypto.com/post/57207/case-for-reg-a-response-commissioner-peirce-sec-token

Is UNI a security: https://www.theblockcrypto.com/post/78231/uniswap-token-security-debate

FCA banning crypto derivatives and ETNs: https://www.coindesk.com/fca-bans-sale-of-cryptoderivatives-to-retail-consumers-in-uk https://www.theblockcrypto.com/post/79911/uk-regulator-fca-bans-crypto-derivatives-retail-users

Securities Clarity Act: https://www.theblockcrypto.com/post/78231/uniswap-token-security-debate

Statement on ATS’s: https://www.sec.gov/divisions/marketreg/mr-noaction/2020/finra-ats-role-in-settlement-of-digital-asset-security-trades-09252020.pdf

SEC chairman Jay Clayton says all stocks could be tokenized: https://www.theblockcrypto.com/post/79783/all-stocks-tokenized-sec-chairman-clayton

Transcript:

Laura Shin: 

Hi, everyone. This is a fireside chat I did with SEC Commissioner Hester Peirce for the LA Blockchain Summit last week. She and I dived into some of the meatiest issues regarding securities regulation of crypto and covered topics such has her dissent in the SEC settlement with crypto company Unikrn, the status of her token safe harbor proposal from the beginning of this year, her views on how securities law applies to DeFi and the recently introduced Securities Clarity act in Congress, among other issues. As usual, Commissioner Peirce, aka Crypto Mom, was thoughtful and knowledgeable about the intersection of securities regulation and crypto. I hope you enjoy this interview as much as I did. And now here’s my conversation with SEC Commissioner Hester Peirce. 

Hi, everyone. Welcome to this fireside chat with SEC Commissioner Hester Peirce, aka Crypto Mom, and thank you Commissioner Peirce for giving us some of your time this week, and congratulations on having your second term as SEC commissioner confirmed in August.

Hester Peirce:

Thanks, Laura, and it’s such a pleasure to be able to be here with you today. I have to start with my standard disclaimer, which is that my views represent my own views and not necessarily those of the SEC or my fellow commissioners. 

Laura Shin:

You began making your mark in your second term almost immediately with the Unikrn settlement in September. At that time, the SEC settled an action against token issuer, Unikrn, and you published a dissent, can you explain why you disagreed with the settlement? 

Hester Peirce: 

I felt that it was a rather heavy-handed settlement for a case where there were allegations that there was a registration violation. There were no allegations of fraud, and so given that, it seemed rather extreme to take the action that we did, which basically was depriving the firm of all its liquid assets, and so that would not be my preferred approach to dealing with a registration violation, and I think that the message that we send with a case like that is one that is basically if you want to do innovation go somewhere else to do it because we really don’t want you to try things here. 

Laura Shin:

As you noted, Unikrn did not commit fraud, but as part of the settlement, it had to permanently disable its tokens and also pay a 6.1 million dollar fine, and you deemed that too harsh because it put them out of business, what do you believe would’ve been the proper penalty? 

Hester Peirce:

Well, I think, we should…look, when there’s a registration violation, and again, I mean, I’m just saying for sake of argument, let’s say there’s a registration violation there, I had my own views on that issue as well, but if there’s registration violation, it’s typical to allow people the right to basically get their money back, and that’s fine, but to essentially take the further step and say we’re going to just take all your assets away, we’re going to penalize you by taking all your assets away, it just seems like a very strange remedy to me for something where we’re just saying there was a problem. Maybe people would want Unikrn tokens to keep running, maybe the people who purchased them would still want them to keep running, and we’re, basically, telling them, no, sorry, that’s not going to happen because we have this other vision in mind, which is to get rid of the tokens.

Laura Shin:

And then, you also just said that you had your own thoughts also on the registration issue, what were those thoughts?

Hester Peirce: 

Well, I think these are really complicated questions, and that’s part of the reason that I think we need a safe harbor. I think it is not always easy to tell whether something is a security or not, but in this instance, I think there was a case to be made that this was not being sold as a security or as part of an investment contract, which is how these tokens tend to get pulled in to the securities analysis, and I just came to a different point on that, but again, I will acknowledge that it’s a grey area and it can be difficult to figure out where things fall.

Laura Shin:

In February, you also proposed a safe harbor for token issuers, which would give teams a three-year grace period in which to decentralize their networks, and as a part of that, you would require the disclosure of certain information such as details about the project or that the code be open soured, the development plan, among other things, what is the current status on this token safe harbor proposal?

Hester Peirce: 

Well, I haven’t yet convinced my colleagues to do something like that. I’m still hopeful that I will be able to. What I’m trying to do now is work on version 2.0 and think about ways that we can incorporate some of the feedback that I’ve gotten, and you know one piece of feedback is people want stronger protections for token purchasers, so are there ways that we can look at some of what’s happening now and the way perhaps people are doing launches of different tokens that might help me think about what we could build into the safe harbor to make it to offer more protection to token purchasers. 

Laura Shin:

And what would be an example of a protection that you might include? 

Hester Peirce:

Well, so you could do something on the disclosure side, and this would be sort of similar to what the EU is talking about in its proposal, which is you could say you can’t market this, and I’m not an expert in EU regulation, but you can’t market this with the idea that the token is going to rise in value, so that would be one option. 

Another option would be to try to take advantage of the technology and build in things that would actually prevent the development team from selling their tokens for particular periods of time, so maybe you could do something along those lines, so those are some of the things I’m thinking about, but still, there’s been a lot going on at the SEC and in the world in general, so there have been a lot of other issues that have been taking my time, and meanwhile, the crypto industry is kind of moving on too, so I do hope that we can move forward with the safe harbor. I still think there’s room for it to do some good, but there are also a lot of other developments happening. 

Laura Shin:

And when you said earlier you have not yet convinced the fellow commissioners or the chairman, have you discussed it with them, and if so, what were their views on it? 

Hester Peirce:

Well, one thing that I never want to do is purport to represent my fellow commissioner’s views. I’ll just say that, you know, I think I still need to do version 2.0 in order to win folks over, and so that’s what I’m hoping to do. 

Laura Shin:

And then, what would be the process after that, like what does it take to get this kind of thing adopted? 

Hester Peirce: 

So, what it would take, I think, it would probably be done through some kind of a rule making and that would mean that we would go out with a proposal, which would then get comment, and then we’d go out with a final version based on the comments that we had received.

Laura Shin:

So, going back to Unikrn, if your safe harbor proposal had been in effect, would you have found that the Unikrn offering complied with the safe harbor? 

Hester Peirce:

Well, so I think that what you need to do, Unikrn would’ve needed to say, hey, we’re taking advantage of the safe harbor, but assuming they had done that, I think it is the kind of thing that could fit very nicely within the safe harbor. 

Laura Shin:

And that’s because they had done some of the disclosures and like what about that particular token would it…?

Hester Peirce:

Well, I mean, again, they would need to make the disclosures required by the safe harbor, but I think that that’s sort of along the lines of what they had in mind, right, they get some venture money at the beginning, and they do a lot of the work, and then they do the launch after that, so I think you can…those are the types of instances in which I think the safe harbor can be particularly useful when there’s been some work done on the frontend that’s been financed by venture capital or other accredited investors, and then, at some point, the company is ready to launch it out into the wider world and have users of the token, and it’s at that point that you would say, hey, we’re taking advantage of the safe harbor.

Laura Shin:

There’s been a new trend in the DeFi space where a lot of these tokens are actually being launched kind of more in the community, and they’re non-VC coins, as the VC coins are being called, and you know it strikes me that your safe harbor proposal maybe is tailored more toward the projects that do start with VC backing, so then does that mean that the community type tokens like these fair launch coins would kind of not be allowed to go that direction or that simply they wouldn’t fall under the purview of this safe harbor proposal? 

Hester Peirce: 

Well, I think that they could. Certainly, that wasn’t what I had in mind when I developed the safe harbor, and I think it’s interesting to see that that’s where a lot of these token launches have moved, and I think that in many ways it’s a really interesting and positive development to see, you know, trying to get the tokens out into the hands of people who are going to use them right away, right, that’s kind of the vision for a lot of these projects, and I think that’s consistent with the idea of decentralization, right, which then takes it outside of the framework, potentially takes it outside of the securities framework, so I don’t know, I’d be interested in getting people’s feedback on whether I need to tweak the safe harbor because I think, as a securities regulator, I probably ought to give the warning or the admonition that no matter what kind of launch you do, you really need to think about whether if you put on the glasses of a securities regulator, especially one looking in hindsight, is that going to look like a securities offering, and so people need to be careful no matter how they’re doing it, and that’s why I would certainly be open to tweaking the safe harbor to accommodate those kinds of fair launch events whatever kind of token distribution event you want to use, I think we need to be thinking about, should this really be regulated as a securities offering or should it be regulated in some other way. 

Laura Shin:

And just to make sure that I’m setting the baseline correctly, I had been assuming that currently the fair launch coins don’t bump against securities law, but I just wanted to check, is that true? 

Hester Peirce:

Well, again, I think people need to think carefully about whether that is the case because even if you do something like an airdrop, that doesn’t necessarily mean that you’re out of the securities law framework, right, so even if you’re not selling it, but you’re basically giving the token out, it could still end up fitting within the securities classification, so people do need to be careful, and again, I think, this is all the more reason why the SEC needs to be out there providing guidance because people are trying to figure out ways to get the tokens out so that people can use the tokens, and we’re not really stepping up and providing the guidance that I think people need to feel comfortable in trying these different methods.

Laura Shin:

So, when you mentioned airdrops, you know, famously, the SEC has indicated that those could be considered securities offerings, and you know, as you mentioned, that’s just where the tokens are given away for free to certain groups. However, in your safe harbor proposal, you actually seem to take issue with the fact that the SEC has indicated that those could be securities offerings, so what is your view on how the SEC should consider airdrops? 

Hester Peirce:

Well, I’m going to give the typical lawyer response that everything is facts and circumstances-based, but you know I think if you are giving something out, it looks very different than if you’re selling something, but again, I caution people that I’m one person on the commission, there are other people on the commission who might look at the same facts and circumstances differently than I do, and so I just caution people to be quite careful in this area. 

I think it’s really interesting that people are coming up with different ways to distribute tokens, and I do think that that should factor into our analysis when we’re looking to see whether it’s a securities offering or not.

Laura Shin:

And it sort of feels like we’re almost dancing around one story in particular that a lot of people have been talking about, which is the launch of UNI, which is the coin for the decentralized exchange Uniswap, after the airdrop of that coin, a lot of crypto lawyers were saying that UNI was almost certainly a security, and I wondered if you agreed with that, and if so, and this kind of goes back to the kind of like VC backed project versus one that is a community launched one, whether you thought that its competitor SUSHI, which kind of is more of a community coin or started that way is also a security or if it’s not simply because Sushiswap was not created by an entity located in a specific jurisdiction? 

Hester Peirce: 

Well, I’m not going to speak about any particular instance. Again, these things all have to be looked at on their facts and circumstances, and so I can’t say anything specific about it other than, again, to urge people to think carefully about the intersection with securities laws even when they’re doing things that they might think are well outside of the securities laws, and please, come talk to us, as you’re thinking about how to do things. I know that I make this plea often, come talk to me, but come talk to our FinHub, our folks on the staff who work on these issues all the time, and they can help you think through some of the ramifications without giving you legal advice, but they can help you think about what kind of questions to ask, so that’s what I would urge folks to do.

Laura Shin:

So, after your safe harbor proposal was published, there were some public responses including from a group of attorneys, one of whom is a former SEC staffer, Zachary Fallon, and the group of attorneys is Ketsal, they are a FinTech compliance firm, and they said that actually they felt that maybe what could be done instead is to just tweak existing securities laws such as regulation A in which token issuers can raise up to 50 million dollars through the sale of what would initially be considered securities, and I wondered what you thought of that idea?

Hester Peirce:

Look, I think that’s an option, too, and I’m certainly open to that option. I’ve always said that my safe harbor is not intended to be the end all and be all or the only solution. If there are other solutions that will work better, I’d rather spend my time working on those, but I do worry if we focus only on a reg A-type solution, we might end up with tokens that are sort of stuck in a securities law framework after a point in which it doesn’t really make sense for them to be in that framework, and again, that’s a project-by-project determination, and it seems to be working for some projects, which is fantastic, but I just worry that that’s not the right model for every token offering, and so certainly willing to be shown that I’m wrong on that, but I think because there’s so many requirements around what it means to be a security and how you can move those tokens around if they are deemed to be securities, that’s where I continue to worry that a reg A solution might not be the only solution we need. 

Laura Shin: 

And so, to go back to DeFi, I wanted to ask a broader question than the question I asked about UNI, which is that in general a lot of these DeFi projects are using what they call a governance token to decide on the direction of the project, and I wondered if you thought DeFi governance tokens were securities? 

Hester Peirce:

Well, again, facts and circumstances, but I think when you start to put security like, equity like characteristics, then, again, that’s going to be something that you have to think about. I say that with a little hesitation only because I think it’s really interesting what’s happening in the DeFi space. You know, I’ve heard you talk about this, Laura, and so I know you feel the same way, but there’s some real potential for some pretty major and revolutionary change coming out of the DeFi space, this idea that you can have the users of something be the ones who also govern it in a really direct…there’s no attenuation there, right, it’s a very direct way, and so that will challenge the regulatory structure in a number of ways, and some of those are on the security side, but I think also on the corporate governance side some of which, much of which, is within state law purview. We’re going to have to ask a lot of really difficult questions about what that means for how we regulate things. 

Laura Shin: 

And I did also hear, in a recent interview, you said that DeFi itself plays a regulatory role, and I love the way you phrase that, it was so interesting to me, and I just wanted to hear you expound on it, what do you mean when you say that? 

Hester Peirce:

Well, I think when you have the people who are actually using something deciding its future, then the changes that happen are decided by the community together, and that’s a sort of regulatory function. It’s not a government regulatory function, but it’s a regulatory function by the people who are actually using it, so someone can launch one of these projects and say I have this great vision for what’s going to happen with this project, but if you really launch it and you put it into the hands of your community, it could end up doing and being something very different than what you initially imagined it to be, it could ultimately be very different, so you have to have a little bit of willingness to be hands-off and see what happens, and that’s probably a little bit scary for some developers to do that, but I think it’s kind of an interesting thing to watch, and it can have some really, I think, positive ramifications for regulating behavior. 

Laura Shin:

So, now, talking about Congress, there was a recent bill called the Securities Clarity Act that was introduced, and that bill would create a new definition for tokens that are between a commodity and a security, and a part of it would be to amend the Securities Act of 1993 and 1940 to say that the term security does not include an investment contract asset, I wondered what you thought of this bill?

Hester Peirce:

Well, so I think it’s really…first of all, it’s good that Congress can get involved when there are questions where two agencies, here the CFTC and SEC, potentially have some jurisdictional claim, but more generally, sometimes what we see when the SEC is a bit slow to act on things is that Congress comes in and says, okay, well, if you’re not going to deal with this, we’re going to tell you how to deal with it, and that can be a really important push for us actually to make some progress on our own, but I do appreciate the fact that there are people in Congress who really care about this space, and it’s a bipartisan interest, which I think is fantastic that there’s real interest in trying to figure out the appropriate regulatory framework, and at some point, there probably will need to be congressional involvement simply because, in the US, there’s so many different regulators involved, both on the federal side and the state side, so I think it’s kind of inevitable that at some point Congress is going to weigh in one way or the other on this. 

Laura Shin:

And just so I understand how something like that would be adopted, if it does get passed in Congress, then would the SEC be able to weigh in, in any way, to amend it or revise it or would it simply be handed down to you, and you would enforce it? 

Hester Peirce: 

So, it depends. Often, what Congress will do is they’ll write a broad enough bill that gives the relevant agency the ability to kind of fill in the details. At other times, Congress will be much more specific, and you know along the way, people from Congress will come to the SEC sometimes and ask for technical advice on what will this mean if we write it this way, and so the experts at the SEC are able to provide technical advice on it, but it just really depends, you know, and it depends on the mood, too, sometimes. We saw, for example, with the Jobs Act that I think there was a frustration in Congress, this was probably before you were following this space, Laura, but there was a real frustration in Congress about the SEC not taking capital formation for small issuers seriously enough, and so Congress came in with the Jobs Act, which told us what we had to do, basically. 

Laura Shin:

For years now, the crypto community has been hankering for a bitcoin ETF, and multiple attempts to create one have been rejected by the SEC. This morning, the UK Financial Conduct Authority banned the sale of cryptocurrency derivatives and exchange traded notes for retail users, what did you think of that decision, and does this also influence the chances of a bitcoin ETF being approved in the US? 

Hester Peirce:

Well, I mean, I don’t even comment on what other regulators in the US are necessarily doing, so all I can…well, I sometimes say, I think there’s been some positive work actually by other regulators in the US in the crypto space, so I’m happy about that, but you know figuring out what products should be available to retail investors is probably a country specific thing. 

What I will say is that in the US, we have a tradition of believing that people should be free to make decisions for themselves and then responsible for the consequences, and I don’t know why that wouldn’t apply in an area like a bitcoin exchange traded product where you see lots of interest from people in getting exposure to bitcoin. This is one way that would be easy for people to get exposure. Again, the facts and circumstances matter, so how the product is designed matters, and that’s something that the SEC looks at, and so each one of these will be judged on its own merits when people come in and apply, but as I’ve said in the past, I think we’ve taken an approach that is a merit regulation approach and is saying we don’t think that investors can make wise decisions for themselves, so we’re just going to cut this product off from them all together, and that just doesn’t make any sense to me. 

Laura Shin:

In the news recently, there were also some really big enforcement actions against the crypto derivatives exchange BitMEX, including criminal charges against its owners, and although this is outside your domain, I wondered what effect you thought this action would have on the industry in general, particularly maybe around KYC, AML, or on future ETF applications? 

Hester Peirce: 

Well, I think that the message has been coming to the industry fairly loud and clear on the AML, KYC front, and I’m sure it will continue. It’s a difficult area frankly for very traditional financial firms, as well, and I think that lots of firms run into trouble there, but I think that it’s definitely sending a message to the crypto world, and then in terms of when there are US users of a product or a service, there’s going to be enforcement of US laws, and so that I think is what we’re probably seeing here, and so we’ll see what happens. As you said, our agency was not involved in that, so I don’t know the details other than what I’ve read in the paper, same as you. 

Laura Shin:

Stablecoins have become a mainstay in the crypto ecosystem with volumes up this year over last, Valerie Szczepanik, the SEC’s Crypto Czar, had said that certain types of stablecoins could raise issues under securities laws, which types of stablecoins do you believe veer more in that direction? 

Hester Peirce: 

Well, I think sometimes when you see a stablecoin that’s built on a basket of underlying assets it could implicate certain of our rules, and so as with anything else, if you’re developing some kind of stablecoin, you ought to come talk to us, but I think there have been some positive developments. I mean, we saw what the OCC did a couple weeks ago, and we came out with guidance or a statement in response to that to say, hey, we want you to come talk to us to see whether there are any securities implications. I think some people took that statement as sort of a negative one, but what I would say is I think it was really saying we don’t think every stablecoin implicates securities laws, but you ought to come and check with us to make sure that it doesn’t, so I think there is a path forward there. 

Laura Shin:

Recently, Chairman Jay Clayton said that all securities may one day be tokenized, do you agree, and if so, what do you think needs to happen before that can become a reality? 

Hester Peirce: 

I think that is likely. You know, we’ve seen the transition from paper certificates where most securities are not evidenced by paper certificates anymore, and so I think it’s a natural progression to think that there will be tokenization and blockchain is a really useful way to keep track of where securities are, who owns them, so I think that we could see that. There probably is work that we need to do on the transfer agent rule making side, and then I think there are technological changes that will have to happen because for something like that to happen, I think everyone in the industry sort of has to get on board, so it can take a longer time for something like that to happen, but you know sometimes it takes an event, like we had the paperwork crisis in the late 1960s, which caused a lot of broker dealers actually to shut down, and so sometimes it takes something like that, and I feel like with COVID, as bad as it is, one thing that it’s made us recognize is that the more we can do to rely on technology, the better we’re set up for when something really terrible happens because you don’t all have to be in the same place, right, and so I think blockchain really lends itself well to the era that we’re in now. 

Laura Shin:

All right, well, we will see where this technology continues to develop. Thank you so much for joining us for this fireside chat. 

Hester Peirce:

Thanks, Laura.