The SEC issued this order last month about how people could trade the stock of public companies using “tokenized stock” – which uses distributed ledger technology. Although the SEC’s order doesn’t force companies to tokenize their shares, it has created a framework under which someone else may attempt to tokenize them – putting the burden on you to be prepared to make a potentially consequential decision within 30 days of receiving notice.
Here are nine things you should know:
- The SEC has opened the door to tokenized stock: In this order, the SEC opened a five-year window by creating an “Innovation Exemption” that allows qualifying tokenized securities venues (known as “TSVs”) and automated market makers to facilitate trading in tokenized versions of exchange-listed stocks, subject to specified conditions. This is an exemptive order – not a new SEC rule – so it’s already effective.
- Your company doesn’t have to tokenize its stock – but someone else may try to (and will send notice to you when they do): Perhaps the biggest takeaway is that an unaffiliated third party may create a tokenized version of a company’s stock. The company does not have to affirmatively participate in tokenization for this to happen.
- Companies have a powerful right to object once they receive notice – and they need to object timely each time: Before a third-party TSV can begin trading a company’s tokenized stock, it must provide written notice to the company. The company then has 30 calendar days to object – and it doesn’t need to give a reason. A valid objection prevents the TSV from listing and trading the tokenized stock.
There is no mechanism to provide a blanket objection and objecting to one TSV notice will not mitigate a failure to timely object to a different TSV notice. If the 30-day window has passed on a particular TSV’s notice, there is no means by which you can later object. - That makes the address on your ‘34 Act filings important so that you see the notice on a timely basis: The TSV sends its notice to the physical or email address for the company’s principal executive offices appearing on the cover of its ‘34 Act reports. Companies therefore need to make sure those addresses are accurate – and, more importantly, actually monitored. A tokenization notice sitting unnoticed in a mailroom or inbox could become a real problem.
- Companies should establish their position before receiving a notice: The 30-day period means this isn’t an issue that companies should first debate when a notice arrives. You might consider running through a drill where you imagine you’ve received such a notice so that you can socialize this issue with the board and top management now.
- A tokenized stock is supposed to preserve shareholder rights: Under the Innovation Exemption, the tokenized stock is intended to represent the underlying NMS stock rather than a synthetic instrument. Token holders are supposed to receive substantially equivalent economic and governance rights, including dividends and voting rights. That distinguishes these tokens from some offshore products that merely track a stock’s price.
- But the plumbing of tokenized stock could be different than traditional stock – including price discrepancies and other issues to consider: Tokenized securities could trade essentially on a 24/7 basis, they could settle nearly instantaneously and they could use blockchain-based smart contracts and automated liquidity pools rather than the traditional exchange order-book structure.
Prices on a TSV could therefore diverge from the stock’s exchange-listed price. This could create a messy nightmare that also involves material announcements, record dates, dividends and shareholder communications.
There also could be third-party compliance failures if a TSV operates improperly. These and other potential problems involving a TSV could potentially create litigation or reputational exposure for companies. - Shareholder records for tokenized stock may be one of the more challenging practical problems: The SEC’ order doesn’t resolve how a TSV’s blockchain records should coordinate with the company’s shareholder list and the records of its transfer agent. This could introduce an environment whereby companies are facing different sets of shareholder populations that are operating through fundamentally different market structures.
- This is a governance risk issue, not merely a crypto issue: The key is to recognize that this is not some sort of crypto issue that you can ignore because your company doesn’t plan to get into the crypto game. Someone else might place your company in that scenario for you.
Authored by
Broc Romanek