Saturday, March 3, 2018
George Geis at the University of Virginia has just posted Traceable Shares and Corporate Law, exploring the implications that blockchain technology will have on various aspects of corporate law that – until now – hinged on the presumption that when one person buys a share of stock in the open market, there is no prior owner who can be identified. The ownership history of a particular share cannot, in other words, be traced.
That lack of traceability has a lot of important effects. For example, it means that if a company issued stock pursuant to a false registration statement, but also issued additional stock in another manner, plaintiffs may not be able to bring Section 11 claims because they cannot establish that their specific shares were traceable to the deficient registration. In the context of appraisal, it has led to questions of whether petitioners who obtained their shares after the record date have an obligation to show that the prior owners of the shares did not vote in favor of the merger (an impossible task). If blockchain technology makes it possible to trace the owners of a share from one transfer to another, these areas of law may be dramatically altered.
The most intriguing part of the paper, however, is where Geis goes further, and inquires whether traceability could cause us to rethink fundamental corporate doctrines. For example, he points out that fraud-on-the-market doctrine is often criticized because some shareholders may benefit from the fraud – in the form of rising share prices – but do not have to pay any damages if they sell before the crash. He provocatively suggests that with traceable shares, subsequent purchasers might have claims against the transferors – which might then incentivize selling shareholders to more closely attend to matters of corporate governance.
I find the proposal fascinating, because it would function, essentially, as a kind of targeted veil-piercing. Though I doubt legislatures and courts would have much appetite for such a rule, it makes for an interesting thought experiment to imagine how it might play out. Presumably, such a rule would not depend on inside information – insider trading prohibitions already would permit disgorgement in those circumstances – so we have to assume the selling shareholders were relying on public information when making their trades. I also assume such liability would be more palatable when imposed on institutional investors of a certain size than on retail investors. Would institutions have a defense if they showed they tried to be good corporate stewards, objected to, say, pay packages that encouraged risk-taking and the like? Especially if they could also show they used an index strategy and so engagement was their only tool to monitor their investments?
One downside, of course, would be potential losses to market efficiency. If shareholders cannot gain by selling stock of companies that they believe are overvalued, prices will become less informative. Indeed, the act of selling out may be exactly the best way to exert pressure on management to govern more responsibly.
In any event, I think Geis is correct when he predicts that traceable shares are in our future – and we may have to rethink a lot of corporate law as a result.