San Francisco-based Securitize has laid claim to being the first “agent” registered by the SEC to have developed an open-source blockchain based protocol for shareholder recordkeeping with active issuers and integration with platforms that allow digital securities to be traded on SEC-registered alternative trading systems. Those include Open Finance Network, tZERO and Sharepost. Securitize’s application with the SEC indicates that it will offer transfer agency services out of its San Francisco and Tel Aviv offices.
So far, the SEC hasn’t provided any public guidance on when firms using blockchain technology should register as broker-dealers, clearing agents or transfer agents despite repeated requests by Templum, a registered broker-dealer operating an alternative trading platform for unregistered digital assets. However, in accepting Securitize’s application, the SEC is suggesting that the current rules for registered equity transfer agents apply to the new blockchain-enabled platforms. Those rules were first adopted back in 1977, long before anyone ever dreamed of blockchain. “To satisfy the transfer agent registration requirements, Securitize must have satisfied the SEC that its smart contracts were capable of meeting the stringent tracking and management solutions of a transfer agent,” says Greg Ewing, a partner specializing in blockchain technology with Potomac Law Group in Washington DC. The SEC declined to comment for this article.
Although pleased that blockchain-enabled transfer agents will fall under the SEC’s oversight, equity transfer agents are not entirely sold on the practical ramifications. “The challenge is that the transfer agency rules are decades old and do not necessarily adapt to the new paradigm,” cautions Kara Kennedy, president of transfer agent ClearTrust LLC in Tampa Bay Florida. She cites SEC Rule 17Ad-11, governing the reconciliation of aged record differences, as an example of an ill-fit with the new blockchain technology. SEC Rule 17Ad-10 requiring transfer agents to post changes to the master securityholder file promptly within 30 days is also superfluous to the blockchain environment, says Kennedy.
Yet another concern: SEC examiners might not be up to speed on the new technology and will struggle to know exactly what to look for or where to look when investigating potential fraud or compliance gaps.”We are in need of some industry dialogue and collaborative education,” says Kennedy. “There is gold to be found in the fire that can be passed along to the next generation of financial entrepreneurs.”
Securitize isn’t the only transfer agent in town when it comes to digital assets. It’s just the one generating the most media fanfare as it is touting its blockchain-based platform which relies on smart contracts as a first with SEC registration. Smart contracts are self-executing agreements acting on the terms embedded on the blockchain.
New York-based Templum Inc., parent company to the SEC-registered broker-dealer and alternative trading system for unregistered digital assets Templum Markets, tells FinOps Report that it also registered with the SEC as a transfer agent back in June 2018. Officials at Templum Inc. would not comment further on the transfer agency service called Templum TA Services, including discussing whose technology it was using, what specific functions it will perform, and whether it will be limited to only those digital assets trading on Templum Markets.
Templum is known for relying on third-party IT and in February 2019 announced it will embed Symbiont’s Assembly in its blockchain and smart contract technology. Symbiont declined to confirm its link to Templum’s transfer agency service. The service has presumably not been implemented based on Templum’s lack of any public announcements.
Securitize appears to be depending solely on its own blockchain based platform which helps firms issue security tokens. The website Crunchbase describes Securitize as early stage venture capital firm raising US$12.8 million in three rounds of funding since its launch in January 2018. Educated in business and computer science in the US, Tokyo and Barcelona, Securitize’s chief executive and founder Carlos Domingo is also the co-founder of Spice VC, a venture capital firm.
In a statement, Securitize says that its transfer agency service can be used for digital securities registered with the SEC and for issuers of Reg A+ and Reg CF digital securities who wish to exempt their digital securities from mandatory registration requirements. Securitize is also marketing itself as as one-stop shop for token services with its Securitize Ready program to assist in issuance, management and compliance. Partners include Coinbase and Open Finance.
“The SEC mandate is that anyone raising between US$20 million and US$50 million under Reg A+ must register their securities and the expectation is that such a registration requires a transfer agent,” says Ewing. “Securitize’s combination of a blockchain platform and registered transfer agent status should be very significant for any company looking to raise money under Reg A+.”
Non-bank transfer agents are required to register with the SEC, while banks are required to register with a bank regulatory agency. Hired by corporations to service their registered shareholders, transfer agents keep records of investors, change share ownership, issue and cancel certificates and make payments. Transfer agents must follow a multitude of SEC rules on annual reporting, record retention and recordkeeping, safeguarding of funds and assets and finding lost shareholders– those whose accounts or payments are unclaimed.
Because blockchain technology inherently provides immutable records all a transfer agent would have to do is prove it can correctly register securities and have control of the records. Securitize says that its DS protocol allows it to register the names of investors, make dividend and interest payments, calculate shareholder votes and conduct redemptions and share buy-backs. Various media outlets have reported that Securitize will incentivize issuers by not charging for its registry services, but that decision could not be independently confirmed. Securitize did not respond to e-mailed questions by press-time.
A June 2018 document on Securitize’s DS Protocol, co-authored by Domingo, lists its smart contracts as DS Apps, exchange-specific DS Apps, voting rights DS Apps and dividend issuance DS Apps. Each investor is identified by a unique ID built from a hash of personal information that includes the investor country, know-your-customer status and accredidation status.
Extending the DS protocol with a Ready for Exchange (RFE) off-chain API allows for the exchange of information between issuers and authorized exchanges not shared on-chain due to privacy constraints, says Securitize’s document. It highlights that the off-exchange exchange of information is useful for the issuer to be able to maintain the cap tables for investors and for exchanges to provide a contact mechanism so the issuer can notify investors of lifecycle events.
The ease with which the SEC has granted blockchain-enabled transfer agents registered status stands in sharp contrast to its inability to help the Financial Industry Regulatory Authority (FINRA) register digital asset custodians as brokers. In a recent joint statement, the SEC and FINRA acknowledge they are stumped with how to apply the customer protection rule to digital asset custodians who want to register as broker-dealers. The impasse has led to a backlog of applications from firms hoping to win business from registered investment advisors which must select a custodian which meets the SEC’s criteria. Only broker-dealers, trust companies, and foreign financial institutions fit the bill.
So far, digital asset custodians who want institutional business have become state-accredited trust companies under New York and South Dakota’s laws. Wyoming law will soon become an option with the state opening applications for new special- purpose depository institutions on October 1. Five firms are expected to apply with the approval process taking at least nine months. The nitty-gritty rules governing the custody of digital assets are expected to be released shortly.