SEC Commissioner Hester M. Pierce says regulators are open to the innovation in a sandbox that needs to not necessarily be government-sponsored. She notes there is a need for open communication and developing understanding in order to come up with regulation that tackles issues that are beyond compliance.
Open Approach to Regulate ICO and Cryptocurrency
The Securities Exchange Commission is adopting an open approach towards regulation of cryptocurrencies to develop a workable regulation. That includes playing their role of protecting investors and users. It also includes understanding the circumstances under which each ICO token is issued without having to have a blanket classification of all ICOs as securities.
commissioner Hester M. Pierce recently remarked before the Medici conference that he is of the idea of not having a blanket classification of all tokens as securities. This is because while some tokens are structured as securities to mean “the investors will expect profits from the activities of another,” there are tokens that do not fall under securities classification.
“Given the undeveloped nature of this area, I am wary of any blanket designation for all ICOs. Instead, the best path forward, at least for the time being, is to evaluate the facts and circumstances of each offering.”
Regulatory Sandbox Mode
She also alluded to the need for players to help and work together with authorities in developing a workable regulation now that SEC and its regulator counterpart the Commodity Futures Trading Commission are treating the field in a regulatory sandbox mode — to mean that cryptocurrencies being a relatively nyoung industry, the regulators are allowing an environment where crypto companies will be able to keep innovating (in order for them to encourage and not stifle innovation) while at the same time identifying the suitable regulation and working on a better regulation that develops from the understanding of the industry.
She said regulatory sandboxes are quite normal all over the world where fintech is concerned, including in Abu Dhabi’s through RegLab and Singapore.
“Under Chairman Chris Giancarlo, our sister agency—the Commodity Futures Trading Commission—has launched Lab CFTC, which “is designed to be the hub for the agency’s engagement with the FinTech innovation community.” And moving a bit closer to this coast, Arizona recently launched the first state-level regulatory sandbox for fintech with the objective of allowing people “to test innovative products, services, business models, and delivery mechanisms in the real market without incurring the regulatory costs and burdens that would otherwise be imposed.”
Step on Developing Better Regulatory Sandbox
However, she said that there is need to develop better regulatory sandboxes that encourage collaboration between regulators and innovators and not those that spoil relationships. For instance, as a commissioner, she is aware that “the temptation to substitute their own judgment for that of consumers and investors is powerful” especially when a regulator is “sitting right there next to the entrepreneurs” in these sandboxes and she says it is not up to the regulator to take the role of “deciding what products and services will win over consumers.”
“The market is efficient at signaling which products and services people want in their lives and which they would rather do without.”
Classification of ICO as securities or not is a learning journey
She also pointed to the need for cryptocurrency companies to collaborate with regulators while the sandbox lasts by saying that “innovations that might otherwise have occurred that don’t fit within that “security” framework may never come to fruition.”
That is not to mean they will be categorizing all ICOs as securities though, but some might finally come to be.
“And there are aspects of certain tokens and ICOs that seem to fit well inside the “security” definition. To the extent that an ICO involves the sale of tokens to investors seeking to realize a profit from the increased value of their coins once the environment is created, it starts to look like a securities offering. At least some ICOs, or aspects of some ICOs, would seem to fall under the SEC’s jurisdiction.”
“Determining the appropriate regulatory regime also will mean determining the shape these transactions will take as they mature. If the coins offered in ICOs are designated as securities, for example, their development and the development of their offerings will track the contours established by the relevant securities laws and regulations. They will, over time, come to look more and more like securities and securities offerings.”
Cryptocurrencies ICOs and the Securities
Classifying tokens as securities are something revered in the crypto-verse for now for the obvious reasons. Would it mean then they are illegal?
She said it was not important to look at the “form” of currency or a token or commodity in order to determine if it is a security but looking at its function is important. And while cryptocurrencies like Bitcoin and utility tokens used in executing a transaction may not likely fall as securities in categorization, the real issue is with the tokens or coins issued in ICOs. That’s where the bone of contention may lie in regard to categorization.
“Although ICOs as a concept is extremely young, the old ways of determining whether they qualify as a security still apply. At its heart, the question is a very basic legal one. We still look to the 1946 Supreme Court decision in SEC v. Howey, which defined a security, among other things, as an investment in a common enterprise with the expectation of profits solely through the efforts of another.”
Regulations & Securities Classification
The commissioner also stated that even if some ICO tokens would fall under the securities classification, it would be the first step towards regulating them. For one, even if they are experts in applying the Howey test, there are many uncertainties in applying regulation in the crypto-verse: they are continually developing understanding in this field. That includes having to determine the “shape these transactions will take as they mature” for instance.
“As I mentioned, I have had to put my student hat back on as I have worked to comprehend what tokens and distributed ledger technologies are and what their potential is. We have staff who are much better versed than I am in blockchain technology. And the coding principles that underlie it, but for many of us in the lifeguard station there is a steep learning curve ahead.”
Second, an evolving regulatory framework is needful in a creative process like this in order to avoid micromanaging an industry.
Third, they are careful to not let their “lack of familiarity with the new technology breed anxiety and therefore bad regulation.”
“There is a risk, when something truly innovative comes along, that regulators will focus only on the harms the innovation may bring and miss entirely the opportunity it presents to improve people’s lives. New technology does often bring with it risks; it can take time and experience for developers to build in the proper safeguards. For example, we have seen lots of cryptocurrency thefts.”
That brings to the fourth reason raised elsewhere. The need to ensure a responsible environment develops in which the investor and user feel safe and secure to invest in.
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Investment in Secured Zone
Already, many companies facing some sort of regulatory investigations are collaborating. It is assumed that if regulation would bring about the environment in which more investors would feel safe to invest in, even companies would benefit. But in her own words, she said it is possible that regulators’ undue focus on potential harm may be uncalled for.
“However, undue focus on potential harm can result in an agency’s leading with its enforcement powers. And ultimately be setting itself up as the industry’s adversary. While a regulator should not be too chummy with the industry it regulates, creating a hostile relationship carries its own risks. Industry participants may be afraid to ask necessary questions and may avoid—rather than speak frankly with—the regulator. The regulator itself then risks becoming blind to the needs of the market, while also potentially missing significant wrongdoing.”
She called for open communication between innovators and regulators without the need for a “government-sponsored sandbox.”
“In a rapidly shifting environment, such as the one surrounding ICOs. It is entirely appropriate for innovators to provide ongoing information to the relevant regulators. This interchange of ideas helps the regulators to understand what is happening. And therefore to feel comfortable exercising proper forbearance as new methods develop. A spirited back-and-forth also helps the regulators do their job better. That job includes evaluating new and existing regulations in light of market changes to ensure those rules are still well-suited to their intended purpose and do not unnecessarily stifle growth.”
That attitude would mean every crypto company would need to review its attitude about regulation and regulators too.
What is your opinion? Do you think the classification of some tokens as securities is a good thing in the end for the industry to mature?