Canada: How Blockchains Will Change Stockholder Democracy

Last Updated: December 15 2017
Article by Donald B. Johnston

Gesundheit!

Generally speaking, when Delaware sneezes, everybody else gets a cold.

That's because Delaware is the undisputed jurisdictional leader in corporate finance in the United States, with well over a million companies incorporated in that state.

Delaware sneezed big time on August 1, when the new Delaware Blockchain Initiative became law. Thanks to this initiative, the Delaware General Corporation Law now permits Delaware corporations to register their shares of stock, and transfers of shares, on a blockchain.

The reason that's revolutionary is this: Delaware companies can now cryptographically link a particular number of shares of stock to a particular owner in a manner that cannot effectively be challenged, due to the more or less bulletproof nature of modern cryptography.

Moreover, because that cryptographic link is recorded on a blockchain, any dealing in any of those "linked" shares can be easily tracked and known to anyone who cares to download a copy of the electronic ledger.

Even better, every dealing in those shares is certain to have been authorized, because that dealing can only be accomplished by the owner of the shares, who possesses the secret "private key" that can cryptographically unlock the shares for transfer to a new owner.

Let's unpack that a bit.

First, the shares are registered electronically on a blockchain.

Second, a blockchain is a distributed ledger (i.e., anyone can have a complete copy) that is mathematically tamper-proof.

Third, only the possessor of the correct cryptographic key can deal with the shares and assign them to a third party. Once the third party is registered as owner, then only that third party can subsequently deal with them. And so on.

Why is this an important initiative?

Traditionally, there has been a good deal of uncertainty of information in share registries. The vast majority of shares of public company stock are registered in "street name" with stockbrokers, and the names of the "real" owners may not be known to the issuing companies, only to the stockbrokers. These days, when an annual general meeting is called, it is the brokers, not the beneficial owners, who get the notice of meeting. Hardly anyone has a paper stock certificate, despite what you learned while playing Monopoly as a kid.

So what will happen when shares are registered cryptographically on a distributed ledger like a blockchain?

  • It is easy for stockholders to register their holdings directly with the public company, rather than having a broker hold them (although the existing system of having brokers hold the shares is also enabled by blockchain technology)
  • Public companies would be better positioned to know who their "real" stockholders are
  • Ownership and control over shares would be demonstrably authentic, while still providing anonymity
  • Legal issues with legal versus beneficial ownership would disappear, and the "real" stockholders would be able to enforce their rights directly, and with the status of actual stockholders, and not merely as persons with "security entitlements" through a "securities intermediary"
  • Public companies could communicate directly with stockholders whose shares are registered on the blockchain – and vice versa!
  • The creation of an accurate cap table would be as simple as making a blockchain database query
  • Stockholders will be able to vote their own shares at annual general meetings, instead of signing proxies (or, more usually, throwing the proxy forms in the trash or forgetting to send them in)

As a result of these changes, it can be argued that the Delaware Blockchain Initiative brings the actual situation much closer to the original intent of the General Corporation Law, which was built on the assumption that stockholders own their shares directly, and not through nominees.

What's more, stockholder engagement will be enhanced, with companies knowing more about who their stockholders are, and being able to talk with them directly rather than through public communications or through brokers and bankers.

This is all good for stockholder democracy and engagement and, if all the other jurisdictions get the "cold" that Delaware is spreading, this initiative could signal a universal change in stockholder engagement and stockholder democracy.

A reminder about blockchain technology

Just in case you are still learning about blockchain technology, here's a bit about what it is.

A blockchain is a peer-to-peer managed, publicly readable, secure database, located in multiple, but isolated/independent, places on the Internet. The data recorded by the blockchain keep on expanding and nothing gets dropped. Every event is date-stamped, encrypted and exceptionally hard to tamper with. Each "entry" in a blockchain ledger is broadcast to every node on the network, which validates and rebroadcasts it. So the blockchain is evidence of "consensus" that all the data are correct.

A blockchain database (sometimes also called a "distributed ledger"):

  • is pseudonymous – every user is represented by a unique mathematical identity, but not by name
  • is a continuously self-linking ledger that potentially has a beginning but no end – each entry is linked to prior entries in a chain-line fashion
  • contains data that are strongly encrypted
  • employs digital signatures of users that are strongly encrypted and bound to the data that the users upload
  • contains data that are time-stamped
  • is recognized as containing valid and correct data that can be relied upon
  • contains records of transactions that have been authorized and confirmed by virtue of unique digital signatures – the signatures are combined with the data to create virtually certain mathematical confirmation of correctness
  • denies incorrect information by virtue of a challenge/response mathematical method
  • is publicly searchable

So there you have it: everything you wanted to know about how blockchain technology is changing corporate law and practice.

I'll write more soon!

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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