Little Known SEC Rule May Limit Early Security Token Adoption

Little Known SEC Rule May Limit Early Security Token Adoption

In 1934, the SEC approved the Exchange Act Rule 12g5-1, which effectively requires all companies with an investor base larger than 2,000 ‘holders of record’ to report as public companies to the SEC. In a recent article, Trent Elmore highlighted the rule’s potential for grave consequences, and how the security token community can overcome such an obstacle.

Many experts conceive of security tokens as changing the entire traditional financial securities structure. The benefits of added liquidity and increased investor-access are expected to disrupt the many legacy systems as seen on Wall Street.

Some have estimated that the security tokens market will reach $10 trillion within the next five years.

Is it possible that all of this futuristic talk is overlooking a historical legal detail? Trent Elmore believes this to be the case, but with a few potential solutions in mind.

The Potential Hindrance of the SEC Rule Explained

In simple terms, the rule states that a company must report— either annually or quarterly— to the SEC, if the company has over $10 million in total assets that are “held of record” by 2,000 holders or more.

This effectively means then, that a securities token enterprise which meets the conditions above will have the costly expenses as that of a public company. The added cost could play a major factor in preventing successful STOs in the imminent future.

So, what are the potential solutions?

How Security Token Enterprises Can Both Thrive and Remain SEC-Compliant

Trent Elmore proposed a few different answers, some with legitimacy, some without.

  1. Smart Contracts

These could prove regulatory compliance by limiting a total number of investors to 1,999. However, some of the biggest benefits of security tokens in the first place include increased investor-access and added liquidity. Smart contracts would seem to eliminate these advantages, resulting in a solution that simply isn’t viable.

  1. SEC Amendment

It is always possible that the SEC could revise the Exchange Act Rule 12g5-1. After all, the rule was initially implemented in 1934, and fails to account for the technology that exists today. However, since the launch of Bitcoin in 2009, the SEC has continuously maintained an unclear stance on securities in the crypto-space, despite many inquiries from congress. It is subsequently unclear as to what it will take for the SEC to come forward with such a revision.

  1. Clarification of ‘Holder of Record’

According to the research of Nick Goss, companies that are required to report to the SEC don’t actually have to list every shareholder. They merely have to report the total number of ‘holders of record’, which essentially means broker-dealers.

In this way, an enterprise could limit the total number of broker-dealers who maintain their security tokens to 1,999, while effectively reaching thousands of actual investors.

A review of a 2012 SEC report indicates Goss is correct:

“Under Rule 12g5-1, a single broker-dealer is counted as one holder of record, even though it may hold securities on behalf of more than one individual beneficial owner. Consequently, the majority of investors owning securities of widely traded companies are not individually reflected on the issuers’ records and are not counted under the current definition of “held of record. In addition, market participants and shareholders may hold through other forms of holding that appear on the company’s stock record book as one record holder, when such record holder holds on behalf of many beneficial owners. In these ways, issuers with more than 2000 beneficial owners, but less than 2000 holders of record, can be actively traded in the over-the-counter markets or in private secondary markets, without triggering the threshold requirements to report under the Exchange Act.”

What do you think of the potential solution proposed by Nick Goss? Will it be enough to prevent unnecessary difficulties for the future of security tokens? Are there any other feasible solutions? Let us know what you think in the comments below.

Image courtesy of Pixabay.

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