Never one to hold back, especially when it comes to crypto and blockchain matters, SEC Commissioner Peirce recently explained her views on the SEC’s settlement with Telegram and the agency’s approach to regulating the crypto and blockchain ecosphere generally. Simply put, Peirce disagreed with the Telegram settlement. In her words: “I do not support the message that distributing tokens inherently involves a securities transaction.” Peirce acknowledged the agency’s mission to protect investors (among other things). However, she once again reiterated her concern that the agency is stifling innovation in the blockchain and crypto space.
By way of background, on June 26, 2020, the SEC agreed to a settlement with Telegram Group Inc. and its wholly owned subsidiary, TON Issuer Inc., to resolve the SEC’s charges that Telegram’s unregistered offering of digital “Grams” violated U.S. federal securities laws. The defendants agreed to return more than $1.2 billion to investors and to pay an $18.5 million civil penalty. For the next three years, Telegram must also give notice to the SEC before it participates in the issuance of any digital assets—not just digital securities, but any digital asset. The settlement did not require Telegram to admit wrongdoing, but neither could it deny the same—the classic SEC no admit/no deny settlement structure.
The settlement seemingly ends what began in the Fall of 2019 with the SEC alleging that Telegram conducted an unregistered securities offering in the U.S. and seeking to preliminarily enjoin Telegram from delivering Grams it previously sold. Telegram agreed to halt its planned delivery of the Grams until the district court weighed in. On March 24, 2020, the U.S. District Court for the Southern District of New York did just that, issuing a preliminary injunction barring the delivery of Grams and finding that the SEC had shown a substantial likelihood of proving that Telegram’s token sales were part of a larger scheme to unlawfully distribute the Grams into a secondary public market.
Peirce’s candor is refreshing, especially in a climate where some regulators may be reluctant to provide more fulsome insight on the basis of their decisions or articulate clear rules or guidance. This is especially important for the SEC, which is not a merit-based regulator, meaning that the agency’s regime is generally designed to ensure that investors have access to sufficient information about a particular company, product, or service to make a fully informed investment choice, but leaves the choice with the investors.
The SEC has, at times, been criticized as deciding winners and losers within particular sectors, and some would say regarding crypto in its entirety, thereby limiting investor choice rather than sticking to its disclosure mandate. Pierce has previously taken issue with what she has characterized as heightened standards resulting in a merit-based approach whenever the crypto markets are invoked. She made her views clear in February 2020 and July 2018 dissents to the Commission’s disapproval of proposals to list bitcoin ETFs. In her speech last week, Peirce again expresses disagreement and dissatisfaction regarding the Telegram outcome, saying “[c]andidly, given the approach we have taken, I often struggle to see a path to compliance; my colleagues sometimes see the sale of a security when all I see is a sale of tokens to be used in a network. How can a token network ever get off the ground if every token distribution event is viewed as a securities offering?”
Peirce provided an interesting and amusing analogy. She recalled a story of the inventor of roller skates who, many moons ago, wore his novel foot contraption to a party, without sufficient brakes, while playing a violin, and ultimately crashed into and shattered a mirror. On the one hand, a regulator at that time could have just prevented him from creating the innovative product in the first place—we may have never experienced roller skates or (gasp) Rollerblades—and therefore saving him the pain and agony of the crash and a potential similar fate for others. But what if, instead of just stopping the roller skate from coming to fruition in the first place, the inventor was provided with a more appropriate environment in which to test his wheels (say, a park instead of a party), or advised on improved braking, or just warned that he should not (or even could not) play the violin while also skating. In Peirce’s view, this is the distinction between “hold[ing] accountable the reckless innovators who skate among mirrors while playing the violin, [and] attempt[ing] to provide the more cautious innovators some guidance on how to avoid the hall of mirrors and on what we consider to be adequate braking technology.” Peirce also refers to “the excitement and messiness of innovation.”
Back to enforcement, Peirce also seems to express her dissatisfaction with the notion of regulation and guidance “by enforcement,” noting that “most of the hints at clarification coming out of the SEC have been embedded in enforcement cases.” Peirce again refers to her roller skate analogy, noting “[i]n other words, rather than provide useful guidance on safety standards and functional braking technology, we simply sue skaters for breaking mirrors.” As many have observed and lamented, Peirce highlights how the SEC’s enforcement settlements “leave the industry to guess at the path to compliance.”
Peirce goes on to essentially characterize the SEC staff’s 2019 Framework for “Investment Contract” Analysis of Digital Assets as complex and confusing. She also cites the staff framework as the impetus for her suggestion of a Token Safe Harbor Proposal. In Peirce’s words, “[t]he safe harbor would allow legitimate token offerings to move forward without having to answer the question of whether the token is a security for three years. During that time, the developers of a token could build the kind of functioning, decentralized network that would push the token clearly outside the securities law framework.”
One of Peirce’s other points is reminiscent of a scene from The Departed, in which Detective Ellerby (Alec Baldwin) questions Sergeant Sullivan (Matt Damon) about the merits of bringing a potential charge—“Cui bono? Who benefits?” Peirce raises a similar question related to the Telegram case, asking “[w]ho did we protect by bringing this action?” She notes that the initial purchasers were accredited investors and that the members of the public who would have purchased tokens in the secondary market would have done so to buy and sell goods and services on the TON Blockchain (not to mention that many of those purchasers would have been outside the U.S.). Peirce questions whether those prospective purchasers would have looked to U.S. securities laws for protection and, at the same time, whether innovators will now take additional steps to avoid the United States.
Peirce’s comments beg the question of whether she would have preferred something akin to the July 2017 “DAO Report” in relation to Telegram. As Peirce points out, even where the SEC believes a violation has occurred, it has the discretion to forego enforcement proceedings and instead “publish information concerning any such violations” (a “21(a) Report”). Like the DAO Report, this approach usually both warns and educates the public about the SEC’s views and expectations in a particular area. This approach is particularly helpful in relation to products and services in uncharted areas.
This is likely not the last we will hear from Peirce on these issues. In fact, just last week, Peirce appeared before the U.S. Senate Committee on Banking, Housing, and Urban Affairs in relation to her nomination for an additional five-year term as SEC Commissioner. With Peirce’s prospective reconfirmation also comes the potential confirmation of Caroline Crenshaw (currently an SEC staffer) as a new SEC Commissioner. On top of that, a leadership change at the SEC is likely soon, given the upcoming election for U.S. President (it is common for the SEC Chair to hand over the reins around this time). Peirce’s experience and voice should play an important role in the direction of regulation in this space for the foreseeable future