Two recent developments hint that blockchain technology, which has the potential to significantly streamline and alter the financial services industry, is slowly moving towards fulfilling that promise. On September 3, 2019, Franklin Advisers, Inc. filed a preliminary prospectus for the Franklin Blockchain Enabled U.S. Government Money Fund, a “blockchain enabled” government money market fund (the “Blockchain MMF”) whose shares would be recorded on the Stellar network.1 Stellar is a decentralized blockchain ledger that requires the use of its own currency (Lumens) to process transactions and prevent illegitimate accounts or transactions. As discussed further below, while the Blockchain MMF is in other respects substantially similar to a U.S. government money market fund registered under the Investment Company Act of 1940, as amended (“1940 Act”), it represents a significant novel step in bringing blockchain functionality to mutual fund operations. And shortly before that, the Securities and Exchange Commission (“SEC”) approved the registration of Securitize, a digital securities platform backed by Coinbase, as a transfer agent under the Securities Exchange Act of 1934, as amended (“Exchange Act”).
The Blockchain MMF
Purchases and sales of the Blockchain MMF’s shares would be made through an app available on major application platforms and recorded by the Blockchain MMF’s transfer agent (the “TA”) in book-entry form and on the Stellar network. According to the filing, the TA’s records will be determinative, but the Stellar network may be the sole record of ownership in the future. Another service provider (the “Blockchain Administrator”) will maintain the app and perform certain “technical and administrative functions in connection with the issuance and ‘permissioning’ of the shares for the Fund on the blockchain (e.g., limiting the parties who can transact on the blockchain).” The Blockchain Administrator will act as the liaison to the Stellar network in recording share issuances and redemptions on the Stellar ledger.
The app required to purchase the Blockchain MMF may be in development as it is not named in the filing. When an investor creates an account, they are provided with a blockchain wallet and a corresponding public and private key pair. Investors would be able to track balances in their wallets through the app or a public “block explorer” tool that shows investment activity in the Blockchain MMF on the Stellar network. The TA and another service provider would maintain the information needed to associate a particular shareholder with the public key, and a digital asset custodian would maintain private keys.
The Blockchain MMF will only accept investments by individuals and corporate investors, and not tax-deferred investors. The Lumens needed to record the ownership of the Blockchain MMF would be paid by the Blockchain MMF’s adviser or an affiliate.2
The Securitize Registration
On August 21, 2019, the SEC approved the registration of Securitize, a digital securities platform backed by Coinbase, as a transfer agent under the Exchange Act. As a registered transfer agent, Securitize is authorized to maintain books and records documenting ownership of qualifying securities3 on behalf of their issuers, among other activities. Securitize is the first4 SEC-registered transfer agent that uses blockchain technology, and it intends to serve as transfer agent for issuers of digital securities.
The SEC’s approval of Securitize’s registration aptly comes not long after the first token offerings of securities were qualified by the SEC under Regulation A under the Securities Act of 1933, as amended.5 Registration as a transfer agent enables Securitize to act as a transfer agent for qualifying securities, as well as securities offered under Regulation A and Regulation Crowdfunding that are exempt from Exchange Act registration.
The eleven assets currently issued through Securitize’s blockchain protocol use the Ethereum blockchain.6 Securitize’s protocol enables digital securities to be traded on SEC-regulated alternative trading systems (ATSs), such as tZERO, OpenFinance Network, and Sharespost.
Securitize will use its blockchain protocol to provide its services to issuers of digital securities. Securitize will be able to keep a real-time capitalization table of investors and facilitate corporate actions for issuers, including, among other things, the payment of dividends and interest, conducting shareholder votes and redemptions and share buybacks.
Key Takeaways
While unrelated, the news of the Securitize approval and the filing of the Blockchain MMF registration statement signal more widespread acceptance of and growing comfort with blockchain technology, both from the regulatory and institutional side of the securities industry.
Although the Blockchain MMF is the first filing by a registered investment company that would use blockchain technology to record ownership of shares, like other registered investment companies, the Blockchain MMF would use a single transfer agent. Additionally, even though the Blockchain MMF will have share ownership recorded on the Stellar network, this record will not be determinative and would therefore not be the sole mechanism relied upon by the Blockchain MMF to record the issuance of its shares or maintain shareholder records.
The parallel recordkeeping structure developed by the Blockchain MMF (with the TA and Blockchain Administrator on the one hand and the Stellar network on the other) is an interim first step towards trying to reconcile rules applicable to 1940 Act-registered investment companies that contemplate a single, accountable entity contracting with the fund to perform a transfer agent function (e.g., registering the issuance of securities)7 with the realities of a decentralized network of independent, anonymous parties performing some or all of these functions.
In the absence of rule changes or exemptive relief, a complete blockchain-based method of recording share ownership for registered investment companies would at least need to fulfill the regulatory functions traditionally provided by registered fund transfer agents, such as the maintenance of shareholder account records and accountable parties to implement policies and procedures to ensure they are accurate and preserved as required. It is hoped that Securitize’s registration as transfer agent signals that the SEC staff is prepared to work with funds to resolve any tensions between the existing rules and technology.
Because this is the first filing by a registered investment company using blockchain technology in its operations and the filing requires SEC staff approval, they will likely comment on the role and structure of the Blockchain MMF’s service providers that require changes or clarifications. Asset managers contemplating using blockchain functionality in a similar way may want to wait until the SEC staff articulates their concerns. Seward & Kissel will continue to monitor these developments.
If you have any questions regarding issues that may arise in connection with activities related to blockchain technology or digital assets, please speak with your Seward & Kissel contact attorney.
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1 The Blockchain MMF filing is available here: https://www.sec.gov/Archives/edgar/data/1786958/000113743919000429/fttn1a092019.htm.
2 The registration statement is silent on what alternatives could be used if the price of Lumens increases significantly.
3 A “qualifying security” is any security registered under Section 12 of the Exchange Act.
4 VStock Transfer, a New York-based transfer and registrar firm, formed Vtoken to act as its security token division, which predates the registration of Securitize, but the Securitize registration appears to be the first successful registration of a transfer agent focused solely on blockchain.
5 The security token offerings of Blockstack PBC and YouNow, Inc. were qualified by the SEC under Regulation A on July 10, 2019 and July 12, 2019, respectively.
6 These assets are tokens issued by Blockchain Capital, SPiCEVC, Lottery.com, Augmate, Aspen Coin issued by the St. Regis in Aspen, CityBlock Capital, 22X Fund, Science Blockchain, Protos, Curzio Equity Owners and Current.
7 See, e.g., Rule 38a-1(a)(2) under the 1940 Act, which requires approval of a transfer agent’s compliance policies and procedures by a fund’s board.
