Tradeable International Private Exempt Securities
2018 will see the rapid emergence of a market for “Tradeable Private Exempt Securities.” It will use blockchains! It will be big! It will be useful! It will have a lot of jargon!
How will we describe “Tradeable International Private Exempt Securities?” ITPES? PETAS? PIETS? PEITS? PITES? TIPES? TRIPES? TIPS? TRIPS? You vote, I promote. We’ll inflict the next horrible acronym on a long suffering world.
Here is what it actually means.
International
Until now, securities have always been issued inside a particular country. If you live outside the country, you can buy the security, but you have to hire a broker in that country.
Our securities will be international because blockchains are borderless. We have found a way to fit them into all of the jurisdictions where we have buyers.
As this new class of international securities will thrives, we will need to explain it to local regulators. We will need an International FINRA to recommend good practices. We are lining up lawyers and brokers to participate in this effort.
International distribution is good because it increases the size of the market. In a global ICO, we often see that only about 25% of the buyers are from the US or China, the two biggest capital markets. This implies that a global offering and trading community will be about four time bigger than a local one.
Tradeable
In the US, many private securities come with a subscription agreement that prevents the buyer from reselling the security, except under specific circumstances approved by the issuer. This makes it easier for the issuer to comply with the rules for handling private securities. However, it is unfortunate, because a security is worth about 25% more (the liquidity premium) if it can be resold.
Our new market will allow trading, because we build the trading rules into the blockchain.
Private Exempt
On the surface, the difference between “public” and “private” securities is that we can sell public securities to anyone, and trade them on exchanges, while we can only sell private securities to selected rich people, and we have restrictions on trading them. This difference between “public” and “private” securities comes from an underlying difference in reporting and disclosure. We can sell a security to the “public” if we follow rituals that are designed to provide public shareholders with the correct type of information to evaluate our investment. In the US we are required to file a prospectus with a carefully designed outline and a boring font, and then be careful about what we say outside of the prospectus. We have to fund auditors and procedures to make sure we can send investors financial reports every quarter and every year. And, if something “material” happens that impacts the business, we have to inform our security owners promptly, through official channels. If we do all of this information sharing, we can be a public company. It’s a lot of work, it costs money, and it can take a long time to organize. It won’t work for a startup. We might have to do it several times because the requirements are different in different countries.
Private securities are “exempt” from many of these reporting and disclosure requirement. We sell them to people who are “sophisticated” investors. We assume they can ask their own questions, and make their own judgments about whatever material the issuer provides them.
These sophisticated investors can meet various kinds of qualifications. In the US, the minimum requirement is $1M in investable funds, or an income of $200K+ per year. QIB (pronounced “quib”) is a higher tier with even fewer trading restrictions that applies to investment businesses with at least $100M under management. Other countries have similar tiers with slightly different requirements and rights. For example, In Japan, a “professional investor” should have $3M in investable funds (Yen 300M), and they can immediately trade the securities they buy.
In the US, a private security can fit into an exemption under Regulation D and Regulation S. This requires that US buyers meet the “accredited” qualification. And, it attempts to prevent backdoor distribution to the public by requiring that they hold the security for at least one year before selling it. This is the rule that applies to almost all startup and SAFT offers. “Rule 144a” is a more exclusive exemption which allows trading between QIBs, and has fewer restrictions.
An international private market will fit a security into exempt categories of buyers in multiple countries.
Whitelisting is the magic technology for staying inside exemptions. We can make a list of buyers that fit the exemption, and put that list inside our blockchain scripts.
The advantage of being exempt is that we can sell securities at an earlier stage, we can sell them in countries that have different public disclosure requirements, and we have more time and attention and money to drive success in the core business.
Is this a good system? It saves a lot of time for issuers if we assume that investors are sophisticated and reduce our disclosure requirements. Maybe less sophisticated investors should be “protected” from buying issues with incomplete information. However, it gives rich people more opportunities to make money than other people, which is unfair. Governments are still debating this question.
The next step — Going Public
By 2019, we will be thinking about taking some of these securities public. In theory, all we need to do is increase the amount of disclosure we do, qualify for public trading in a particular country, and then we can expand our whitelist to include anyone in that country.
In practice, we will need to fix the exchange system. A following article will cover changes in exchanges.
