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From Securities Regulation Daily, May 9, 2018

Commissioner Peirce suggests regulators should leave room for innovation

By Rodney F. Tonkovic, J.D.

Regulators should leave plenty of room for innovators to develop their ideas instead of sitting at their shoulders during the innovative process, suggested SEC Commissioner Hester Peirce.

In her remarks before the May 2, 2018 Medici Conference, Peirce addressed emerging technologies and the challenge that innovations such as ICOs and tokens present to regulators. According to Peirce, determining the appropriate regulatory regime can shape these types of transactions, but there is also the potential to thwart innovations that don't fit within that framework.

Sandbox or beach? Peirce observed that there has been a lot of talk about "regulatory sandboxes" in Washington, D.C. Regulatory sandboxes let businesses test promising innovations without undue regulatory burdens. But, Peirce said, regulators are sitting in the sandbox with these entrepreneurs. She suggested instead that a regulator is like a lifeguard at a beach who watches what is happening but doesn't sit with the "sandcastle builders." In this analogy, the regulator welcomes engagement, but leaves room for innovators to develop ideas without sitting at their shoulders and taking part in the decision-making.

She then asked: "How can I, in a sense, be a better lifeguard?" Innovation is a challenge for regulators, she stated, because applying rules grown in response to past technologies to new ideas is difficult. Understanding concepts in the area of crypto-technology requires Peirce to re-think things she thought she understood, and she asked the audience for help in learning about how to think about regulatory obstacles standing in the way of crypto-technology’s "ability to improve our lives."

Tokens. Peirce then turned to the subject of tokens and the challenges they present to established norms. She noted that the tokens or coins used in initial coin offerings look the most like securities, but are they functionally securities? Here, Peirce pointed to the 1946 Supreme Court decision in SEC v. Howey which is still used to define securities. The Howey test looks to function, not form, she said, and this is an important question that has ramifications beyond matter of regulatory compliance. ICOs are in their infancy, and determining the appropriate regulatory regime will also shape these transactions as they mature, while at the same time possible stifling innovations that don't fit within the regulatory framework.

An appropriate regulatory structure must be devised for those ICOs and tokens that do come under the SEC’s jurisdiction, but there are many traps for regulators along the way, Peirce continued. The SEC must be careful not to let a lack of familiarity with the new technology breed bad regulation. Regulators also need to avoid micromanagement that can result in forcing new technologies to fit into existing, but ill-fitting, regulatory frameworks. In short, regulators need to resist the temptation to substitute their own judgment for that of consumers and investors.

Here, Peirce returned to the idea of regulatory sandboxes, pointing out that what troubles her about them is that the regulator is sitting right there in them with the entrepreneurs as facilitator and host. There can be open communication between innovators and regulators without government-sponsored sandboxes, she suggested, and the best path forward is for regulators to approach ICOs and tokens with intense curiosity. To that end, Peirce recommends that the Commission set up a website devoted to questions and comments about ICOs, tokens, distributed ledger, and other crypto concepts. This would provide the opportunity to open-source answers to some of the challenges in this space, she said.

In closing, Peirce said that she hopes that these waters can be navigated collaboratively. Innovation happens organically, and the SEC's role is not to hand out permission slips, but to protect investors and the integrity of the market. It is important, however, to not lose sight of the benefits of new technology while doing so, she said.

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