The SEC has secrets. And those secrets might be shaping the way cryptocurrency and blockchain companies do business.
Earlier this week, SEC Commissioner Hester Peirce, affectionately known as “Crypto Mom” by crypto kids the world over, delivered a speech at the annual SEC Speaks event in D.C. entitled the “SECret Garden.”
In her speech, Peirce acknowledged the daunting complexity of federal securities laws—the finer details of which, the budding crypto industry is still learning to handle. These intricacies can “create a compliance minefield for market participants,” Peirce said. And “unraveling that complexity can be a matter of professional life and death.”
Absent sweeping changes to existing rules and statutes, the Commission necessarily relies on staff-level guidance or relief to help provide markets with clarity, she said.
The problem, as Peirce described it, is that the process of providing this sort of guidance isn’t always transparent—often, it’s done informally, behind closed doors, and locked within what she characterized as the SEC’s “secret garden.”
The result is a “fatal competitive disadvantage,” she said, for the startups and entrepreneurs who aren’t privy to the SEC’s secret garden—or the “secret law” that resides within it.
“[I] have grown increasingly concerned that this necessary guidance—due to a lack of transparency and accountability—may have turned into a body of secret law,” Peirce said. “This secret law, as a practical matter, binds market participants like law does but is immune from judicial—and even Commission—review.”
Her concerns aren’t unfounded, says securities litigation attorney Jake Chervinsky. “I agree with Commissioner Peirce's eloquent description of the body of ‘secret’ law developing behind the SEC's closed doors,” he says. “In my own experience as a securities litigator, I can tell you that lawyers are often exposed to valuable insights from SEC staff in the course of confidential conversations that other market participants will simply never know.”
In this regard, Peirce zeroed in on the process of obtaining an SEC no-action letter, and the lack of transparency involved therein, as particularly problematic.
A no-action letter is a form of relief that market participants can obtain by explaining to the Commission the details of their respective businesses, why they shouldn’t be a problem with regard to securities laws, and essentially gain exemptions from enforcement action.
No-action letters aren’t legally binding and can be rescinded if the circumstances change. But they are functionally binding in the way Peirce describes and, when “used appropriately, can be extraordinarily helpful to market participants, particularly when no-action positions are made public, as they generally are today,” she said.
The crypto community received something of an introduction to the world of no-action relief last week, when the SEC granted the first letter of its kind designed for a blockchain-based business: TurnKey Jet and its TKJ token.
James Prescott Curry, attorney for TurnKey Jet, says the process—from the time he initiated contact with the SEC, to when the Commission finally published the letter—amounted to roughly 50 phone calls over the course of 11 months. A solo practitioner from Jupiter, Florida, Curry says the experience was initially unnerving:
“It was a little intimidating at first, because I’m reading other no-action letters, and they’re from global law firms, basically. So I’m sitting there thinking to myself, ‘man.’ ”
In the end, Curry says he came away feeling very satisfied with his dealings with the SEC—TurnKey Jet got the assurance from the Commission that it wanted. It can sell its tokens without registering the sale or filing for an exemption and without fear of enforcement action from the Commission. And while the core concept of TurnKey Jet’s model for its token remained in tact by the end of it, says Curry, some concessions had to be made.
Developing the letter was an iterative process and changes were required before it could be finalized. For example, in order for the letter to be approved, Curry had to remove all references to Ethereum—or any specific blockchain network—as well as the ability for TKJ tokens to be transferred to digital wallets outside of TurnKey Jet’s networks and traded on secondary markets.
While these changes ultimately fit TurnKey Jet’s business model, it’s these sorts of discussions—informal guidance about specific technology developed privately by SEC staff—that Peirce says she worries are not receiving the kind of public scrutiny and oversight they deserve.
No-action letters, at their end point, must be made public by rule—but draft letters and other forms of “non-public guidance” do not. Yet they are being used to form “law” just the same.
“In the enforcement context, some decisions are made quietly without a formal no-action letter, press release, or other notice to the public, resulting in exactly the type of ‘secret’ precedent that Commissioner Peirce identified in her remarks,” says Chervinsky.
Peirce said that she has grown increasingly convinced over the last 15 months that the line between helpful non-public guidance to “something more akin to secret law” is being repeatedly crossed.
“For example, when I hear that staff simply will not accept certain applications for entire categories of products or types of businesses for reasons not found in our rules, I wonder whether that line has been crossed,” she said. “Or when I hear that examiners and SROs are examining firms against the terms of draft no-action letters and notes of telephone calls with Commission staff, I am confident that line has been crossed.”
In other words, well-meaning companies looking to play by the book may be unwittingly placing themselves in the SEC’s enforcement crosshairs—their businesses examined and potentially targeted based on unpublished guidance that was never subject to public oversight or accountability.
Crypto Mom never once said the words “crypto” or “blockchain” in her speech, but the implications for the industry as intimated by her concerns are impossible to ignore.
“Given the context, I felt that, at least in a few places, Commissioner Peirce was speaking directly to the blockchain and crypto community,” says Lewis Cohen, attorney and co-founder of DLx Law. “Commissioner Peirce is right to raise concerns about an over-reliance on non-public guidance. Personally, I’d like to see more of the staff’s guidance made public.”
Chervinsky adds that Peirce’s observations “are especially poignant for stakeholders in emerging and innovative markets who have found the SEC's opaque and informal processes difficult to navigate.”
Conversely, regulators have likewise had a difficult time navigating industries built around nascent technologies, and Cohen says it's worth acknowledging the challenge that the SEC is facing in working "to understand an incredibly diverse variety of new business models and subtle legal questions."
"The new Token Framework is a great first step, and I am very encouraged that we are moving in the right direction,“ he says.
Indeed, for years, regulators have demanded that crypto work its way out of the dark. Perhaps it’s time the SEC did the same.