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Treasury Management

A Blockchain Move You Can Use Now

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July 31, 2017

Finally, a blockchain application that will directly benefit corporate finance executives.

Distributed ledgerPromises of blockchain technology revolutionizing business have abounded over the last few years, but so far, few practical applications for corporate treasury have emerged. But that’s now changed. On July 24, the governor of Delaware inked into law the ability for companies to keep their internal corporate records in blockchain format in addition to existing formats, such physical or electronic certifications.

“The use of blockchain technology to maintain a Delaware corporation's stock ledger in accordance with the new law would allow the different permitted nodes to agree on particular transfers of shares and register those. Then that becomes a part of the company record, rather than a secretary in a backroom writing this down in a ledger book,” said Matthew O’Toole, a partner at Potter Anderson Corroon.

Nodes are the computers connected to a blockchain network that validate transactions and maintain copies of the blockchain. The Delaware law recognizes that the blockchain created by these nodes, which form what’s referred to as a distributed ledger, is an acceptable means by which companies can keep books and records.

Mr. O’Toole was chairman of the corporation law section of the Delaware State Bar Association, and a member of that group's committee that essentially prepared the blockchain-related amendments that were approved by the Delaware legislature on June 30. He noted that the amended law is technology agnostic and thus permits the use of any blockchain, including existing blockchains such as bitcoin and Ethereum.

The Delaware Division of Corporations is considering how to apply the new law. Andrea Tinianow, director of the Delaware Blockchain Initiative, said that Symbiont’s distributed-ledger technology will be integrated with the State of Delaware Division of Corporations, noting that the new law provides the regulatory framework for Delaware corporations to use the technology. She did not provide a timetable.

“For new companies it is pretty straightforward. They will be able to incorporate right there on the distributed ledger and set up a stock ledger,” Ms. Tinianow said, adding that for existing private and public companies, converting their ownership to the blockchain will be more complicated, and that the issue is being explored by Delaware lawyers specializing in corporate law.

Issuing bonds via a distributed ledger should prove to be much easier, since bonds don’t have to be issued in indirect (depository eligible) ownership form and can be created in digital form at their inception, with all subsequent transactions recorded in a blockchain.

“If the securities are not digital at the genesis moment of their creation [in a distributed ledger], then it’s not possible to completely digitize end-to-end all the workflows related to that instrument,” said Caitlin Long, president and chairman of the board at Symbiont.

Long added that she anticipates “within the next 12 months to see a tier one corporate issuing a bond via blockchain, and frankly once one does a lot more will follow.”

A bond could be issued using blockchain technology from Symbiont or another vendor specializing in “smart contracts,” which are computer protocols enforcing the terms of a contract. However, new companies registering in Delaware, including special purpose vehicles set up to issue asset-backed securities, will use Symbiont’s blockchain technology.

“With a securitization, there are clear advantages to registering the SPV in blockchain format,” Ms. Long said.

The benefit to issuing bonds and other securities via blockchain technology is that it creates a presumably immutable record that gives the issuer transparency into who owns the securities. In the case of stock shares, companies would be able to monitor whether activist or other investors were accumulating significant blocks. Companies would have the same transparency into their bondholders, a major benefit if the company is planning a liability management initiative, such as General Electric’s recent spinoff of its financial services unit, because issuers have no way to find or directly communicate with all the owners of their bonds.

“If I’m a corporate treasurer, I welcome that because if I ever have to do an exchange offer on a bond issue, I need to find those investors, and that can be especially challenging if they’re overseas,” Ms. Long said.

Applying blockchain technology to publicly issued stock is more complicated because today federal securities law requires those securities to be issued in depository-eligible form—indirectly, in “street name”—and the certificates representing those securities held by Cede & Co., a subsidiary of the Depository Trust & Clearing Corp. (DTCC). Investors essentially hold a derivative of those securities, and Wall Street accounting systems can inadvertently create additional shares. In a recent case involving Dole Food Co., for example, it became apparent there were 49.2 million valid claims on the company’s equity shares but only 36.7 million had ever been issued.

“If a company wants to keep an accurate record of who owns its shares and more importantly how many shares are actually outstanding, it has to maintain those records itself,” Ms. Long said. “But now that’s not possible under the indirect model where the actual ownership of securities is not by the people who think they own them.”

Because bonds aren’t required to be issued in indirect ownership form, it’s easier to issue bonds in a form that can be held directly by investors.

Newly created private or public companies will be able to register share transfers relatively easily using a blockchain to maintain the books and records of ownership in the private company or publicly issued stock. Investors in the stock would hold those securities directly, and not in street name.

For existing companies that long ago incorporated through the Delaware Division of Corporations, in addition to having to deal with the indirect-ownership issues, there may be certificates held outside Cede & Co. To record its stock on a blockchain, the company will have to find the owners of those certificates so they can be surrendered to the corporation and transmuted to digitized form.

“As a practical matter, if a company has lots of investors holding certificates, it’s unlikely all the certificates will be surrendered, so companies in those circumstances face a challenge in implementing a blockchain-based stock ledger. Our firm is looking forward to helping Delaware corporations best manage that situation,” said Potter Anderson Corroon’s Mr. O’Toole.

In the meantime, Overstock.com, which issued preferred stock in digital format last fall, announced July 19 that its Medici Ventures, created to manage and oversee its investments in firms building blockchain solutions, plans to become one of the first entities to convert its registration to blockchain form at the State of Delaware. It will use the amendments that Delaware Governor John Carney signed into law and take effect August 1. Medici Ventures also plans to use blockchain to administer its fund interests from inception, providing its investors with end-to-end recordkeeping on a blockchain and administration of investor interests using smart contracts.

“When Overstock went public in our IPO in 2002, I had no choice but to sign over ownership of my personal shares to the [DTCC’s] Cede & Co. Thanks to Delaware’s new law, entrepreneurs won’t be forced into such a Faustian bargain anymore as the admission ticket into the club of publicly-traded companies, because Delaware is giving entrepreneurs a path to retaining direct ownership of their shares after their IPOs,” said Dr. Patrick Byrne, CEO and founder of Overstock.

He added that Overstock is currently “studying opportunities” for Overstock’s shareholders to gain direct ownership of its shares at some point.

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