United States: Blockchain And Public Securities: Shedding Light On 'Going Dark'

The application of blockchain technology to the securities market could prove to be a game changer by adding transparency, reducing costs and speeding up settlements.

Initially known as the technology underlying the cryptocurrency Bitcoin, "blockchain" is a distributed digital ledger technology used to confirm transactions and record ownership of assets, among other potential use cases. At a fundamental level, a blockchain is a type of database. What makes a blockchain different from most other databases is the way in which users interact with the database. For example, common attributes of blockchain implementations are that they are "distributed" and "self-proving" such that the digital ledger is maintained by consensus through a network of users (or organizations), as opposed to a single copy maintained by a centralized authority.

The blockchain distributed ledger technology promises a more efficient, secure and transparent mechanism for storing, tracking, trading and verifying assets and information. Proponents of the technology believe it has the potential to drive positive disruption across many industries, including the financial services industry. Some would argue nothing is more ripe for disruption than the book-entry system used in connection with share ownership.

The Current Approach to Recording Stock Ownership

Historically, the stock of a corporation was represented by physical stock certificates. These certificates were exchanged, revised and/or reissued each time the stock was traded. Over time, a system developed in which intermediaries became the holders of most certificates, and the stock could be traded underneath these intermediaries without the need to exchange, revise or reissue any of the certificates. The intermediary holder of the certificate is the "holder of record," while the investors for which the intermediary is holding the certificate are the "beneficial" or "real" owners of the stock at issue. Although an investor's broker may be the intermediary that is the holder of record, the vast majority of stock held in the United States is held by an affiliate of The Depository Trust Company called Cede and Company.

Many federal and state corporate and securities laws are built around the holder of record concept, and this creates issues because, in most cases, the holder of record is not the ultimate beneficial owner of the stock at issue. For example, under many state corporate statutes, only the holder of record may exercise certain rights as a stockholder. While a stockholder may choose to receive a certificate and become a holder of record, there is concern that the rights of beneficial owners are not fully realized as a result of the fact that the stock's holder of record must be the one to exercise such rights.

Another example relates to the Securities and Exchange Commission's (SEC's) requirements regarding public filings. A company that has fewer than 300 holders of record may choose to cease filing its financial statements and other disclosures with the SEC, even while the stock continues to trade publicly. This is called "going dark." According to a recent Wall Street Journal article, "more than one-fifth of the 1,500 largest companies in the U.S. have fewer than 300 shareholders of record. Eight companies with market values of at least $1 billion each report having no more than 10 shareholders of record."1 While we are not likely to see many large corporations "going dark," the risk of companies going dark could be alleviated if there were a simple way to break the distinction between holders of record and beneficial owners, such that all owners of a company's stock may be counted as holders of record.

Though most securities held today are still held in the form of physical certificates, a new system has been developed in which the physical certificates are replaced by electronic certificates. This is known as the "book-entry system." The book-entry system is an improvement over the use of physical certificates, but the dichotomy between holders of record and beneficial owners still exists, as do all of the problems associated with this dichotomy.

Issuance of Digital Securities

Using blockchain's distributed ledger technology could help solve some of these issues through increased transparency. Recently, Overstock.com gained SEC approval to issue up to $500 million in equity or debt securities that would trade on a digital platform, where ownership of the digital securities will be reflected in a publicly distributed, proprietary ledger maintained by an alternative trading system operated by a subsidiary of Using blockchain's distributed ledger technology could help solve some of these issues through increased transparency. Recently, Overstock.com gained SEC approval to issue up to $500 million in equity or debt securities that would trade on a digital platform, where ownership of the digital securities will be reflected in a publicly distributed, proprietary ledger maintained by an alternative trading system operated by a subsidiary of Overstock.com. The digital securities are evidenced only by entry into the publicly distributed ledger, and transfers of digital securities can only be effected on that ledger. This new application of blockchain technology to the securities market could prove to be a game changer by adding transparency, reducing costs and speeding up settlements.

Under the current book-entry system, the issuer of securities does not have direct insight into who are the beneficial owners of its securities. With a distributed ledger, such as the one used by Overstock.com, retail and institutional investors could open accounts for trading in digital securities instead of acting through brokers. As a result, the issuers of a security would have the ability to see the identity of those holders and the ability to see who holds the securities in real time.

The Delaware Blockchain Initiative

Under the corporation laws of several states, including Delaware, only stockholders of record can propose directors for election, and, in proxy contests, companies have refused to allow stockholders to propose directors if they were not stockholders of record. While both federal securities and state corporation laws are probably in need of amendment with respect to "shareholders of record," a share register using blockchain would likely lead to a good solution for all interested parties.

The state of Delaware has recognized the problem, and there is movement afoot to encourage legal changes that would allow and promote a distributed ledger-based share ownership system as part of Delaware's blockchain initiative. While still in its initial phases, Delaware Governor Jack Markell has announced his support for the creation of a new method of representation of corporate share ownership, in which all Delaware corporations will soon have the ability to issue shares using distributed ledger technology. As part of the initiative, the governor has appointed Andrea Tinianow as the state's blockchain ombudsman to spearhead the effort. In addition, Delaware has launched a proof of concept with Symbiont — a blockchain technology provider — to develop distributed ledger solutions for archival records for the state. Given the large percentage of Fortune 500 companies that are incorporated in Delaware, the blockchain initiative could provide a spark to ignite the fire of disruption with this exciting new technology.


1 Jason Zweig, "Shareholders Are Disappearing Before Our Eyes," The Wall Street Journal (June 10, 2016).

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