Saturday, March 3, 2018

As Matt Levine would put it, blockchain blockchain blockchain

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.

Ann Lipton | Permalink


Thought-provoking. I think we know that consuming the fruit of the tree of knowledge of good and evil is not an unmixed blessing. In this case it seems that traceability could promote greater justice in a lot of individual cases, at the potential cost of much greater, widely-diffused damage resulting from sand in the gears of the market. The ability to investigate the identity, and potentially the motives, of every seller and purchaser of securities could be a lot of sand.

So, what would be the balance between individual benefits and diffused damage? Would 300 million investors effectively be chipping in $1 each (extracted in the form of damage to the market), balanced by 1 million defrauded investors getting average settlements of $300 each from previously-undiscoverable claims? Or would that $300 million in individual justice cost other market participants a billion dollars? Or $150 million? Strikes me as pretty unknowable.

But speaking of unknowable, an intriguing question about universal traceability might be, are there currently any major market dysfunctions *that we are now utterly unaware of* that could be exposed, or solved, by blockchain traceability? And is it necessarily true that solving dysfunctions would be beneficial to investors? (What would be the effect on securities markets if all the dirty money were forced to go elsewhere?) Somewhere in the back of your mind you’ve got to wonder if the spreading adoption of blockchain traceability could end unexpectedly in some form of blockchain singularity event. Think ice-nine for markets.

Posted by: Scott Killingsworth | Mar 3, 2018 10:05:40 AM

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