Sujeet Indap, Financial Times
September 11, 2017
For Patrick Byrne, the iconoclastic chief executive of internet retailer Overstock.com, a financial system reliant on intermediaries coming between buyers and sellers has persisted for far too long. “For 6,000 years we have been using third party institutions because we trust these institutions. But these institutions have ways of getting corrupted over time,” says the libertarian and Wall Street sceptic.
Overstock is among the first companies incorporated in Delaware to consider cutting out the middleman in corporate record-keeping. On August 1, the state, where most US businesses are incorporated, enacted legislation that allows companies to use distributed ledgers, also known as blockchain technology, to store their share registers.
The current hype around blockchain is largely focused on the prospect of getting rich by speculating on bitcoin and other coin offerings that are based on it. But those who have been sounding the alarm on the financial system’s creaky plumbing should be equally enthusiastic.
That is because the current low-tech share bookkeeping system is indirect and esoteric. It often struggles because assigning company shares to their underlying owners is not straightforward, as several recent high profile Delaware lawsuits, including one involving the mutual fund T Rowe Price, have starkly demonstrated.
T Rowe had been a critic of the 2014 buyout of technology company Dell. It was aggrieved enough about the deal price that it brought an “appraisal” lawsuit, asking a Delaware judge to award investors a higher “fair value” for their shares. But the law around appraisal is very specific: shareholders who want to pursue the process must both hold their shares through the closing and vote against the transaction. Because of the vagaries of the current share register system T Rowe failed on both counts, through no real fault of its own.
When stock trading exploded in the 1970s, moving around paper stock certificates became impractical. Banks and brokerages set up depositories and stocked them with jumbo certificates that represented bulk shares. Today, just one depository remains, DTC, and almost all US stock certificates are issued in the name of DTC’s nominee, Cede & Co. Shares are fungible across institutions which have customer accounts. But that means that individuals and funds are not quite official share owners.
For technical reasons that arise from the certificate system, T Rowe’s shares inadvertently left Cede’s possession for another nominee when T Rowe exercised its appraisal rights. This disqualified the fund group from seeking appraisal even though it never sold its shares. In another blunder, T Rowe’s instructions to vote against the Dell deal failed to make it through the layers of its custodian bank, the DTC to the firm that executed voting instructions.
Another recent Delaware lawsuit over the buyout of Dole Food led to the owners of 49m shares claiming they were owed part of the settlement proceeds even though only 37m shares were outstanding. The discrepancy came because DTC takes three days to settle trades and both buyers and sellers claimed to own the shares.
Results in tight shareholder votes have also been questioned for similar reasons, according to a speech by Delaware vice-chancellor Travis Laster advocating for a blockchain system.
In a blockchain ledger, the DTC layer is eliminated. Ownership rosters are updated transparently and in real time. Many companies chose to domicile in Delaware because its corporate law is the most advanced of any US state. Its quick acceptance of blockchain signals that it does not want to lose its pre-eminence to other states.
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Overstock, which accepts bitcoin as payment, is a natural candidate for blockchain shares. Its venture capital subsidiary, Medici Ventures, has invested in Symbiont, a company developing the smart contract foundation of the Delaware blockchain. According to Matthew O’Toole, an attorney who studied blockchain for the Delaware State Bar Association, start-ups which are creating share ledgers from scratch have expressed the most interest in blockchain bookkeeping. Existing companies would have to go through a process of unwinding existing stock certificates.
“What the internet did to traditional publishers, blockchain will do for a hundred activities,” Mr Byrne predicts.
Should companies be slow to adopt this far superior shareholding system, investors, who are bearing the cost of the current inefficiencies, should demand it.
This article originally appeared in and is copyrighted to the Financial Times.