SEC Seeks More Feedback on tZERO’s Proposed Security Token Exchange

The U.S. Securities and Exchange Commission (SEC) is extending the timeline for it to approve or disapprove operations by a security token exchange affiliated with Overstock’s tZERO.

In a letter dated April 1, the SEC presumably wasn’t joking when it said it was looking for analysis and input on the BOX Options Exchange’s proposed rule changes to commence operations of its new Boston Security Token Exchange (BSTX).

BSTX, a joint venture between BOX and tZERO, filed rule change proposals detailing its operations last year. BOX more recently filed an amendment to one of its proposals, increasing the number of market makers and heightening its listing standards.

In Wednesday’s document, touching on one of these proposals, the SEC said it specifically wants feedback on whether the proposed exchange’s operations are consistent with parts of the Securities Exchange Act of 1934, as well as whether the information it has provided so far are sufficient to make a ruling on approval.

The commission warned that if not adequately addressed, these hurdles would be grounds for disapproval.

Third parties can weigh in on the proposal either online or by emailing the SEC (those who email should include “File Number SR-BOX-2019-37” in the subject line). They have three weeks from the document’s publication in the Federal Register to submit initial thoughts, and a further two weeks to offer any rebuttals to others’ comments.

“The Commission asks that commenters address the sufficiency of the Exchange’s statements in support of the proposal, which are set forth in the Notice,72 in addition to any other comments they may wish to submit about the proposed rule change,” the document said.

Headwinds

A number of concerns have been raised around the BSTX proposal by third-parties. On March 27, Nasdaq Senior Vice President Joan C. Conley wrote a letter to the SEC raising concerns about how the proposal placed an “unreasonable burden on competition” due to the underlying blockchain technology (distributed ledger).

Conley stated the technology used to track ownership of the security token would not share a common distributed ledger. Instead, BOX would be the sole user, retaining exclusive ownership that would place other exchanges at a competitive disadvantage.

“The most salient characteristic – indeed, the only unique characteristic – of the security token is its use of blockchain technology,” Conley wrote. “To avail itself of blockchain technology, the purchaser must be a BSTX Participant. Non-BSTX Participants would be subject to ‘omnibus’ blockchain reporting.”

This would in effect allow BOX to promote trading of some securities in its own favor because other exchanges would be unable to trade these tokens, she wrote.

The New York City stock exchange also questioned what it saw as insufficient detail relating to digital securities infrastructure and its compatibility with existing equities market infrastructure as well as the impact on anti-fraud, customer protection and possible investor confusion.

“Nasdaq recommends that BOX submit additional detail addressing these concerns before the proposal is approved,” the exchange said.

Market Impact

The comments follow other concerns expressed by David Shrader of the Paykin Krieg & Adams law firm, Ellen Greene with the Securities Industry and Financial Markets Association (SIFMA) and Benjamin Connault of the IEX stock exchange, among others.

Greene and Shrader both indicated that the filing documents around the exchange had not been widely disseminated to the broader securities market. All three wrote that more time is needed to consider the proposed rule changes.

In her letter, Greene wrote that “SIFMA remains concerned that approval of the collective filings could be a significant change for the equities markets,.”

Shrader, writing on a client’s behalf, went further, saying that BSTX needs to provide more clarity around how security tokens would settle, how market participants would verify ownership of a security token in compliance with know-your-customer and anti-money-laundering rules, as well as a number of other issues. 

Indeed, BSTX needs to clarify why a blockchain-based exchange would be superior to a traditional one, he wrote.

“It seems likely that the introduction and use of ‘Security Tokens’ will create undue burden on market participants, exchanges, custodians, clearing firms, retail and institutional investors,” Schrader wrote.