Although blockchain and smart contracts continue to push illiquid private securities secondary market towards greater transparency and liquidity, the US Securities and Exchange Commission is mulling a possible comprehensive update to their regulatory framework.
The SEC has issued a concept release regarding the simplification, harmonization, and improvement of its exempt offering framework,
Jay Clayton, SEC
"We are taking a critical look at our exemptions from registration to ensure that our multifaceted private offering framework works for investors and entrepreneurs alike, no matter where they are located in the United States," said SEC Chairman Jay Clayton in a prepared statement. "Input from startups, entrepreneurs and investors who have first-hand experience with our framework will be key to our efforts to analyze and improve the complex system we have today."
As part of the release, the regulator may consider revising the exemptions governing the secondary trading of private securities as well as who may invest in the securities and how much they may invest.
After the introduction of the JOBS Act in 2012, which raised the investor threshold for private securities from 500 to 2,000, it took only three years for private securities issuances to outpace the issuance of registered securities, Vincent Molinari, CEO of Templum Market, told Markets Media.
"Since then, we've seen the increased trajectory of private unregistered issuances north of $3 trillion and the public market between $1.6 and $1.8 trillion annually in the US," he said.
The primary reasons for such illiquidity are the lack of visibility, asymmetrical distribution of information, and lack of market infrastructure, and has lead private securities to trade on the secondary market with 20% to 40% discounts.
"Putting them on a path to visibility, this would improve the liquidity while reducing the amount of associated discount," said Molinari.
Templum, which operates an SEC-registered alternative trading system, has developed a smart securities framework for private securities that incorporates existing market standards, such as CUSIP instrument identifiers.
"We have existing regulatory frameworks that, if digitizing a security, you could adhere to the same framework without re-inventing the wheel," he added.
New and many of the existing Reg D offerings can adopt Templum's smart securities format. However, some early initial coin offerings may find themselves in the electronic equivalent of no man's land.
Sub-standard ICOs that did not adhere to the SEC's securities exemptions cannot trade on crypto exchanges since the Commission has deemed them securities nor can they trade on ATS platforms since they were not appropriately issued, according to Molinari.
"Any remediation process also could be challenging for the issuers since they cannot offer a recession because they have no capital left for anyone who would want to hit the rescission," he added.
In the meantime, the digitalization of the secondary private securities market continues to advance, but it is not a quick process.
"We hear people discuss digital securities being in its early innings, but we tend to look at it and say that stadium is being built and the game is just beginning to be played," said Molinari. "It's less than version 1.0 and maybe emerging to go into that version 1.0."
