A full Life-Cycle of Security Tokens

Stefan Perlebach
Jun 20, 2019 · 8 min read

In our new Series “Walk me through the process” we will learn and understand more about the cost-saving effects & efficiency improvements blockchain technology / Security Tokens can bring to the financial industry.

This week we are welcoming Brian Collins from Horizon Globex (Globex), on a mission to:

“ reduce friction from securities issuance to secondary trading — by using blockchain technology”

Brian will help us to understand how technology can be used to maintain compliance and efficiency throughout an entire Security Token Offering by comparing it to the traditional approach. Furthermore, Globex developed a user journey for issuers and investors that takes full advantage of blockchain technology without having the investor use any cryptocurrency, being regulatory aligned and adding in necessary investor protections to keep everyone happy.

Enjoy the Interview.

What problem is Globex trying to solve?

Globex aims to lower the barriers of entry for issuers and investors to compliantly and efficiently participate in the digital evolution of securities. We’ve spent the last two years developing an end-to-end suite of blockchain software solutions that address the full life cycle of digital securities offerings (aka security tokens), including tokenization, KYC/AML, custody tools for transfer agents, and dollarized secondary trading. Our goal was to combine our team’s backgrounds in Wall Street and Silicon Valley in order to develop technology which addresses the gaps we saw when it came to infrastructure, compliance, investor protection and user-friendliness.

What are the most common methods for issuers to raise funds today?

As the blockchain community knows, digital securities offerings (DSOs), or security token offerings (STOs) conducted and disseminated using blockchain technology must comply with SEC guidance regarding what constitutes a security when involving US investors. Current options to offer securities include:

  • Registered offerings of DSOs utilizing Form S-1
  • Private offerings of DSOs utilizing Rule 506(c) of Regulation D (Reg D)
  • Exempt offerings of DSOs utilizing Regulation A+ (Reg A+)

The most common method to date for digital securities issuance has been to rely on Rule 506(c) of Regulation D. This option is great, but only allows accredited investors to participate. While issuers have filed offerings with the intent of having such offerings qualified pursuant to Regulation A+, which allows accredited and non-accredited investors to participate, none have yet been qualified by the SEC. We’re anticipating that once Reg A+ offerings begin to be qualified and the market/ regulation continues to mature, we’ll begin to see digital securities issuers consider the S-1 IPO option as well.

What are the obstacles and limitations investors and issuers are facing today using these methods?

For traditional securities issuances, the biggest obstacle is the manual time, money and energy put into a mostly manual and paper-based system for issuing securities. It’s a slow process. Additionally, for Rule 506(c) of Reg D, and Reg A+, the ability to utilize modern forms of communication and marketing to attract investors is a new concept which makes education and trust critical. A new layer of complexity is added when blockchain becomes involved.

One of the biggest obstacles we’re seeing when it comes to applying blockchain technology to the issuance of digital securities is the lack of infrastructure that aligns with regulatory requirements. Many companies in the community are attempting to change regulator’s viewpoints very quickly, which we don’t believe will ultimately be successful. We believe that although regulatory changes and interpretations of existing regulations pertaining to blockchain transactions will continue to evolve, we expect that it will take some time before the regulatory environment is able to fully disintermediate securities transactions using a public blockchain.

We, therefore, take a unique blockchain approach that we believe is aligned with the current regulatory environment. We’ve built our software solutions to comply with today’s regulatory landscape, with the ability to seamlessly evolve to changes as our securities regulators continue to become more comfortable with blockchain technologies.

For example, some issuers are attempting to qualify their Reg A+ offerings, which requires the use of a transfer agent in the majority of cases. Anticipating this hurdle, we’ve built our CustodyWare solution, which we believe to be the first regulatory compliant product for U.S. transfer agents to custody and manage digital securities on behalf of their clients.

How can Security Tokens improve the process for investors? What are the overall benefits that can be generated?

Digital securities offer many benefits to streamline, modernize and digitize the investment process.

Removing friction: A big misconception when it comes to digital securities is that it alters the actual process for issuing securities. This isn’t true. What it does do is remove friction and speed up the process.

Transparency: With blockchain technology, the process becomes much more transparent. All transactions from the onboarding process to the transfer of securities can be recorded on the public blockchain. This is why Globex built its “tech stack” on top of the Ethereum public blockchain. The blockchain is now protecting both the investor and issuer. Investors can be assured their data wasn’t tampered with at different stages of the offering, issuers maintain a record for enhanced shareholder management, and immutable transaction reporting is available for regulatory oversight.

Distributions & payments: Right now, for a traditional security, if a company needs to issue a dividend, they go through transfer agents, who would physically mail a check to investors. The process is slow and inefficient. Using our blockchain technology, our CustodyWare solution facilitates the transfer agent in paying US Dollar dividends to shareholders with the click of a button.

Potential liquidity: The blockchain also adds greater potential for liquidity, as investors are able to trade globally, 24/7, with T+0 settlements through a much more efficient and transparent process.

Can you give us an example how the traditional process of a Security Offering looks like today by walking us through it Step by Step.

Process for a traditional issuer (for a Regulation D offering**):

  1. Issuer, counsel and investment bank draft the offering documents including a private placement memorandum (PPM) and a subscription booklet
  2. Investors are onboarded manually, materials necessary for KYC and AML checks are posted in or faxed over
  3. Issuer’s bank gathers materials and organizes them for KYC review and onward AML screening on the banks’ backend against a proprietary AML database; can take 5–10 days to complete
  4. Investor funds the offering with ACH or wire transfer to bank or escrow
  5. Once all investors are on-board, then a closing-call is undertaken by issuer, issuers counsel, escrow agent, transfer agent, bank and banks counsel where the cap-table is passed by email (or post) to a Transfer Agent
  6. Transfer Agent transcribes the list of holders into their proprietary database
  7. After a few weeks, the Transfer Agent issues a share certificate (or book entry position) and posts it to each investor
  8. Issuer now needs to negotiate with a regulated stock exchange (NYSE, Nasdaq, OTC Markets etc.) to list their security for secondary trading

From receipt of KYC information, issuing securities, funding a company and receiving a share certificate can take over 6 weeks!

Process for a traditional investor (for a Regulation D offering**):

  1. Investor reads the materials
  2. Investor downloads and signs each document
  3. Investor manually sends in materials manually or faxes them in for KYC/CIP/ AML and accreditation
  4. Once investor is cleared, they send a check, ACH or wire money to investment bank or escrow account
  5. Transfer Agent eventually issues a share certificate (or book entry position) and posts it to each investor
  6. Securities must be held the statutory period before resale can occur and may be subject to additional restrictions
  7. Investor now waits for the issuer to create a secondary market for the security

From receipt of KYC information, issuing securities, funding a company and receiving a share certificate can take over 6 weeks!

**This is a sampling of the steps required to complete an offering and additional steps and processes are required. It is highly recommended that the Issuer engages securities counsel for full details.

Can you give us an example how a Security Token Offering using the solution of Globex would look like in comparison?

Process for a digital securities issuer (for a Reg A+ and a Reg D/S offering**):

  1. Issuer, counsel and investment bank draft the offering documents including a private placement memorandum (PPM) and a subscription booklet
  2. Globex publishes a customized smart contract for the issuers’ ERC-20 digital securities
  3. Globex publishes a white-label KYC/AML app for the issuer to onboard investors
  4. Bank (or other regulated entity) takes 1.5 minutes to verify an investors KYC submission and run AML checks using the Globex portal
  5. Investor funds the offering with ACH or wire transfer into escrow
  6. The bank issues the digital securities to the investors Ethereum wallet and automatically custodies them with an SEC regulated Transfer Agent smart contract
  7. Transfer Agent releases legitimate digital securities from custody to an SEC regulated ATS smart contract for compliant secondary trading

From receipt of KYC information, issuing securities and the funding of a company can take less than 15 minutes!

Process for a digital securities investor(for a Reg A+ and a Reg D/S offering**):

  1. Downloads KYC/AML onboarding app through Google Play Store or Apple App Store
  2. Goes through a 2-minute KYC/CIP process with the app auto-adjusting depending on investor’s jurisdiction and regulatory requirements (Ethereum wallet can be created directly in app for simplicity)
  3. Once cleared, email is sent to investor with the account to send money to
  4. After investment amount arrives, banker approves and bank will issue digital securities tokens to investor’s wallet
  5. Securities must be held the statutory period before resale can occur and may be subject to additional restrictions
  6. Once holding period is complete, investor simply transfers their digital securities to an SEC regulated ATS for secondary trading
  7. Investor places on Offer to sell their securities on the exchange or ATS in exchange for US Dollars (only for ATS powered by Globex)
  8. Investor withdraws US Dollars from the exchange or ATS to their personal bank account (only for ATS powered by Globex)

From submission of KYC information, funding the investment, receiving securities and trading on an ATS can take less than 15 minutes!

**This is a sampling of the steps required to complete an offering and additional steps and processes are required. It is highly recommended that the Issuer engages securities counsel for full details.

What are the biggest upcoming challenges for Security Tokens to thrive in the future?

For digital securities to thrive, we believe that creating the infrastructure for a liquid secondary trading ecosystem is the most important. This is why our focus is on powering decentralized global exchanges with necessary layers of centralization that address secondary trading issues head on, including solutions to help prevent common problems in over the counter market, such as pump and dump schemes, correspondent banking issues, and lack of efficiency. Without somewhere for issuers and investors to freely trade, the issuance will be illiquid, and investors will not be able to generate a return on their investment. This is why right now; our biggest focus is on powering global digital securities exchanges and ATSs which will allow for compliant and efficient secondary trading.

Education is also key to making digital securities on the blockchain mainstream. Right now, blockchain technology is closely tied to cryptocurrencies. However, “blockchain does not equal cryptocurrency”. Cryptocurrencies are merely the first use case presented to the public using blockchain technology. The underlying distributed ledger technology is what is being used to evolve today’s capital markets and securities. And this is the technology we are harnessing in our software solutions to help make this a reality.

Thank you for the Interview!

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