THIS DOCUMENT IS FOR DEMONSTRATION PURPOSES ONLY AND SHOULD NOT BE USED AS LEGAL OR FINANCIAL ADVICE.
Ether [...] is one of the lower principles of what we call primordial substance, one of the dreams of old, and which has now become again the dream of modern science.
--H.P. Blavatsky, The Secret Doctrine 1888
This document proposes a corporate governance structure for Primal ETH, a Delaware company. As Primal ETH seeks to brand itself as an Ethereum-specific fundraising portal, an overall goal for this corporate structure is to use Ethereum-based applications wherever practicable.
This document is split up into the following three sections: (1) Stock; (2) Shareholder Voting; and (3) Board of Directors. Each of these sections will give a brief overview of a proposal, followed by the relevant law governing each proposal, then followed by a more detailed explanation of the proposal.
The stock will be a restricted class with voting rights. It will be held in a smart contract and paired with ETH so that it is dynamically priced similar to Uniswap exchanges, with the smart contract being the sole liquidity provider. In order to receive the stock, purchasers must obtain a Verification Token, which can be obtained through another smart contract that acts as a faucet. The purchaser must give us his/her name and mailing address in exchange for the verification token so that ownership may be reflected on our corporate ledger, as is required by Del. law.
We should offer the stock in compliance with SEC Rule 506(c), which allows solicitation only to accredited investors. The SEC definition of an accredited investor includes (but is not limited to): (1) an individual with high net worth or high income; (2) an organization, corporation, or trust with a high net worth; (3) institutional investors like banks, insurance companies, mutual funds, and certain employee benefit plans; (4) insiders of the organization such as directors and officers; (5) venture capital funds that offer managerial assistance to the organization; and (6) entities in which all the equity holders are accredited investors. Therefore, we need to follow proper procedures that an ETH address is owned by an accredited investor before issuing a Verification Token. This violates the ethos of open source, but because our company is at the early stages of its development we don't have the resources available to offer to the general public.
Summary: Corporate records can be stored using distributed networks, as long as the corporate ledger can be used to prepare a list of stockholders.
Any records administered by or on behalf of the corporation in the regular course of its business, including its stock ledger, books of account, and minute books, may be kept on, or by means of, or be in the form of, any information storage device, method, or 1 or more electronic networks or databases (including 1 or more distributed electronic networks or databases), provided that the records so kept can be converted into clearly legible paper form within a reasonable time, and, with respect to the stock ledger, that the records so kept (i) can be used to prepare the list of stockholders specified in §§ 219 and 220 of this title, (ii) record the information specified in §§ 156, 159, 217(a) and 218 of this title, and (iii) record transfers of stock as governed by Article 8 of subtitle I of Title 6. Any corporation shall convert any records so kept into clearly legible paper form upon the request of any person entitled to inspect such records pursuant to any provision of this chapter. When records are kept in such manner, a clearly legible paper form prepared from or by means of the information storage device, method, or 1 or more electronic networks or databases (including 1 or more distributed electronic networks or databases) shall be valid and admissible in evidence, and accepted for all other purposes, to the same extent as an original paper record of the same information would have been, provided the paper form accurately portrays the record.
Summary: Restrictions on stock transfers are allowed as long as the restriction is "noted conspicuously" on certificated stocks or contained in notices for un-certificated stocks. The restrictions are binding on successors. These restrictions are presumed reasonable if done for the company to keep or hold a regulatory advantage. In our case, the advantage is preventing the stocks from being listed on an exchange, or otherwise publicly transferable, so as to avoid SEC penalties.
(a) A written restriction or restrictions on the transfer or registration of transfer of a security of a corporation, or on the amount of the corporation's securities that may be owned by any person or group of persons, if permitted by this section and noted conspicuously on the certificate or certificates representing the security or securities so restricted or, in the case of uncertificated shares, contained in the notice or notices given pursuant to § 151(f) of this title, may be enforced against the holder of the restricted security or securities or any successor or transferee of the holder including an executor, administrator, trustee, guardian or other fiduciary entrusted with like responsibility for the person or estate of the holder. Unless noted conspicuously on the certificate or certificates representing the security or securities so restricted or, in the case of uncertificated shares, contained in the notice or notices given pursuant to § 151(f) of this title, a restriction, even though permitted by this section, is ineffective except against a person with actual knowledge of the restriction.
(b) A restriction on the transfer or registration of transfer of securities of a corporation, or on the amount of a corporation's securities that may be owned by any person or group of persons, may be imposed by the certificate of incorporation or by the bylaws or by an agreement among any number of security holders or among such holders and the corporation. No restrictions so imposed shall be binding with respect to securities issued prior to the adoption of the restriction unless the holders of the securities are parties to an agreement or voted in favor of the restriction.
(c) A restriction on the transfer or registration of transfer of securities of a corporation or on the amount of such securities that may be owned by any person or group of persons is permitted by this section if it:
(1) Obligates the holder of the restricted securities to offer to the corporation or to any other holders of securities of the corporation or to any other person or to any combination of the foregoing, a prior opportunity, to be exercised within a reasonable time, to acquire the restricted securities; or
(2) Obligates the corporation or any holder of securities of the corporation or any other person or any combination of the foregoing, to purchase the securities which are the subject of an agreement respecting the purchase and sale of the restricted securities; or
(3) Requires the corporation or the holders of any class or series of securities of the corporation to consent to any proposed transfer of the restricted securities or to approve the proposed transferee of the restricted securities, or to approve the amount of securities of the corporation that may be owned by any person or group of persons; or
(4) Obligates the holder of the restricted securities to sell or transfer an amount of restricted securities to the corporation or to any other holders of securities of the corporation or to any other person or to any combination of the foregoing, or causes or results in the automatic sale or transfer of an amount of restricted securities to the corporation or to any other holders of securities of the corporation or to any other person or to any combination of the foregoing; or
(5) Prohibits or restricts the transfer of the restricted securities to, or the ownership of restricted securities by, designated persons or classes of persons or groups of persons, and such designation is not manifestly unreasonable.
(d) Any restriction on the transfer or the registration of transfer of the securities of a corporation, or on the amount of securities of a corporation that may be owned by a person or group of persons, for any of the following purposes shall be conclusively presumed to be for a reasonable purpose:
(1) Maintaining any local, state, federal or foreign tax advantage to the corporation or its stockholders, including without limitation:
a. Maintaining the corporation's status as an electing small business corporation under subchapter S of the United States Internal Revenue Code [26 U.S.C. § 1371 et seq.], or
b. Maintaining or preserving any tax attribute (including without limitation net operating losses), or
c. Qualifying or maintaining the qualification of the corporation as a real estate investment trust pursuant to the United States Internal Revenue Code or regulations adopted pursuant to the United States Internal Revenue Code, or
(2) Maintaining any statutory or regulatory advantage or complying with any statutory or regulatory requirements under applicable local, state, federal or foreign law.
(e) Any other lawful restriction on transfer or registration of transfer of securities, or on the amount of securities that may be owned by any person or group of persons, is permitted by this section.
§230.506 Exemption for limited offers and sales without regard to dollar amount of offering.
(a) Exemption. Offers and sales of securities by an issuer that satisfy the conditions in paragraph (b) or (c) of this section shall be deemed to be transactions not involving any public offering within the meaning of section 4(a)(2) of the Act.
(b) Conditions to be met in offerings subject to limitation on manner of offering—(1) General conditions. To qualify for an exemption under this section, offers and sales must satisfy all the terms and conditions of §§230.501 and 230.502.
(2) Specific conditions—(i) Limitation on number of purchasers. There are no more than or the issuer reasonably believes that there are no more than 35 purchasers of securities from the issuer in any offering under this section.
Note to paragraph (b)(2)(i): See §230.501(e) for the calculation of the number of purchasers and §230.502(a) for what may or may not constitute an offering under paragraph (b) of this section.
(ii) Nature of purchasers. Each purchaser who is not an accredited investor either alone or with his purchaser representative(s) has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment, or the issuer reasonably believes immediately prior to making any sale that such purchaser comes within this description.
(C) Obtaining a written confirmation from one of the following persons or entities that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has determined that such purchaser is an accredited investor:
(1) A registered broker-dealer;
(2) An investment adviser registered with the Securities and Exchange Commission;
(3) A licensed attorney who is in good standing under the laws of the jurisdictions in which he or she is admitted to practice law; or
(4) A certified public accountant who is duly registered and in good standing under the laws of the place of his or her residence or principal office.
(D) In regard to any person who purchased securities in an issuer's Rule 506(b) offering as an accredited investor prior to September 23, 2013 and continues to hold such securities, for the same issuer's Rule 506(c) offering, obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor.
(Italics added)
The stock is a restricted class, meaning in this case that the stockholder is only able to transfer the stock back to the Company's smart contract. This restriction is in place so that the Company's corporate ledger reflects the ownership of the stock, as required by § 224, as well as to prevent the stock from being sold on a secondary market, thus triggering SEC regulation. In order for someone to purchase Primal ETH stock, they must have an Ethereum account with one of our Validation Tokens.
In order to accept an incoming transfer of Primal Token, an Ethereum address must have a Validation Token. The Validation Token must, at the very least, verify that the owner of the Ethereum address has submitted his/her name and mailing address so that it can be recorded onto Primal ETH's corporate ledger. The Token must also be non-transferable so that another unregistered ETH address cannot use it to purchase our stock and so the Token doesn't end up on a secondary market.
In an open world, the corporate ledger would be updated automatically. Here is an example of what our ledger should reflect:
| Eth Address | Name | Address | Shares |
|---|---|---|---|
| 0x9d6d492bD500DA5B33cf95A5d610a73360FcaAa0 | John Smith | 555 Aether Drive, New York, NY | 100 |
| 0x9d6d492bD500DA5B33cf95A5d610a73360FcaAa0 | Jane Roe | 444 Satoshi Wei, Denver, CO | 250 |
Information regarding the stockholder's name and address should not be made public or stored on the blockchain.
There is the question of what happens if someone gives our ledger a fake name and address. Purchasers should be warned beforehand, and even perhaps be forced to agree to a click-wrapped agreement, that if they give false information, their stock could be dissolved. If we suspect fraud, we could verify the account by sending a letter to the address provided. If we receive a return-to-sender, we could freeze the account until or unless the person listed in the ledger can verify his/her information.
For this project, we likely don't have to worry about fake names/addresses because, as explained below, we will likely have to sell stock exclusively to "accredited investors."
Which brings us to another question, which is whether we should allow anyone with an Ethereum address to purchase Primal ETH stocks this way. There are two options here: (i) permissionless stock sales; and (ii) permissioned stock sales.
With a permissionless stock sale mechanism, Validation Tokens would be given to anyone who submits their name and address. This mechanism seems to fit in well with overarching ethos that decentralized and permissionless are the only way forward in the cryptocurrency space. In addition, since the Private Placement Exemption allows sales to non-accredited investors under certain circumstances, it doesn't seem implausible to devise a permissionless mechanism compliant with the black-letter Rules.
However, SEC dicta when it comes to cryptocurrency seems to imply that selling to the general public will invite scrutiny, even absent explicit statutory violations. In other words, if companies sell to the public, the SEC will find a reason to shut you down. Take this passage from the DAO report for example:
Anyone was eligible to purchase DAO Tokens (as long as they paid ETH). There were no limitations placed on the number of DAO Tokens offered for sale, the number of purchasers of DAO Tokens, or the level of sophistication of such purchasers.
DAO Token holders were not restricted from re-selling DAO Tokens acquired in the offering, and DAO Token holders could sell their DAO Tokens in a variety of ways in the secondary market and thereby monetize their investment..."
Later on in the report while applying the Howey Test, the SEC emphasized that "form should be disregarded for substance." The underlying policy at play, which is also the very impetus for the creation of the SEC, is need to protect unsophisticated investors from losing their life savings in unregulated offerings and sales of securities. In implementing this policy, the SEC will use all mechanisms at its disposal. In this vein, even absent a clear statutory violation, the SEC could argue that a permissionless sale of equities puts the unsophisticated public-at-large at risk and therefore it should be shut down. This is just speculation, of course, but it does seem to fit with the SEC’s recent actions regarding digital assets. To put it another way, without modern legislation regulating cryptocurrency, the SEC is forced to use the ambiguity inherent in current laws in order to carry out policy.
To illustrate, consider the ban on advertising and general solicitation for securities offered under the 506(b) exemption. Issuers aren't allowed to sell securities by means of, including but not limited to, "Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio." Is Twitter considered similar media? Is GitHub? Could what you're reading right now be a violation? If my characterization of the SEC is right, any ambiguity like this would be held against us if we opened our stocks up to non-accredited investors.
There's always the option of fighting enforcement actions in court, but the time and expense needed for such litigation would be high, and the risk and reward would be low. Courts generally defer to agencies (see (Chevron v. Natural Resources Defense Council, Inc.)[https://www.law.cornell.edu/supremecourt/text/467/837]), which means we'd be fighting an uphill battle. There's also the likelihood of our reputation being damaged by the mere accusation of wrongdoing, which will likely be disseminated in the press and on social media. As such, any reputation we might've earned with the community for implementing permissionless trading of our stock could be offset by agency pushback and negative media coverage.
Which brings us to the permissioned option. Delaware law allows directors or stockholders to decide the terms of restricted stock. We could let either group vote on whether to issue a validation to a new investor after an opportunity to assess the investor's character and background. With fewer, accredited investors, Primal ETH appears to have more of the substance of traditional, private corporations. In addition, we'd be able to solicit our offering under a Rule 506(c) to accredited investors. The rule explicitly allows attorney to certify whether an investor meets the “accredited investor” standard.
Offering only to accredited investors, of course, only perpetuates the problems of income inequality and classism by excluding average investors in favor of experienced and wealthy ones. Not only is this detrimental public policy, but it could also harm our reputation. The problem is that the Federal Government and the states (referred to collectively as Sovereigns) have an interest in keeping citizens solvent. For example, impoverished citizens are more likely to use public resources like Medicare (or the state equivalent), welfare, and subsidized housing. To this end, if a publicly distributed asset bubble pops, Sovereigns would become overwhelmed with wards. To prevent this, Sovereigns bar the average citizen from investing in certain speculative assets. The Federal Government accomplishes this through the SEC, and the states have equivalent local authorities.
However, this restriction on investment also act as a gatekeeper, preventing the average citizen from purchasing high risk/high reward investments (unless the state is the beneficiary of the purchase as in the case of state lotteries). These investment opportunities therefore are in the sole domain of elite investors, who're often times already wealthy. Thus, as the old saying goes, the rich get richer and the poor get poorer.
This is particularly evident in the case of accredited investors (detailed at Line 19): the SEC restricts many investment opportunities to wealthy organizations and individuals with high net worth or net income. Defenders of this restriction argue that it protects the average citizen from unscrupulous offerors looking to take advantage of the “little guy.” On the other hand, many see the accredited investor standard as a classist mechanism that keeps power and opportunity in the hands of the rich by unfairly tying one's net worth and income with one's ability to assess a potential investment.
This labyrinth of competing policies is something we should keep in mind in case we're able to find an equitable path forward, and--on a personal note--I really would like to find a practical way to eliminate barriers to entry like this. But for now, since we're a new startup with limited resources, we should probably take the easier path forward, which is to only offer to accredited investors. Thus, I recommend for now we build a permissioned mechanism for issuing verification tokens and structure the offering in compliance with Rule 506(c).
Once an Ethereum address has a Validation Token, and we have a name and physical address associated with that account (and for now, we certified that he/she is an accredited investor), the purchaser can purchase stock from our smart contract. A purchaser will initiate the exchange of ETH for stock by sending an amount of ETH to the smart contract. The smart contract will check to make sure msg.sender's balance of validation tokens is >= 1, then send stock to the purchaser's address (or else return error). The stock should be dynamically priced similar to Vitalik Buterin's blog post that was the impetus for Uniswap, with the smart contract getting the sole benefit of increased fees.
The purchaser can only sell the stock back to the Company. The process for this would be that the stockholder would click on a "sell" option and be told the current dynamic price for the stock. If the stockholder sends stock back to the smart contract, the corporate ledger would ideally automatically update, and the stockholder would get an amount of ETH (as determined by dynamic pricing) in return.
Annual stockholders’ meetings would be conducted remotely on a company webpage. Holders of Primal stock could nominate directors and vote on directors in a DAO-like setting (Aragon?). We would need to record the stockholders who are present for our corporate records. The meeting would be conducted through a streaming service. There is an Ethereum-based streaming service called LivePeer, which we should utilize if practicable (or something similar).
Each director will receive his/her voting token from the stockholder meeting. Starting off, the voting token will allow the directors to vote for proposals in a specific decentralized autonomous organization (DAO). A quorum will require at least 2/3 of directors to vote, and a simple majority vote by directors should suffice to pass a proposal. Meetings can be carried out remotely in accordance with Delaware law.