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As Dave recently shared, the SEC has granted a 5-year exemptive order to “Tokenized Securities Venues” that are trading tokenized National Market System stock under certain conditions. This Gibson Dunn blog outlines what the relief does – and does not – do:

The Innovation Exemption does not grant any relief to the entity doing the tokenizing. The NMS Stock may either be tokenized by, or on behalf of, the issuer of the underlying NMS stock, or by a third party unaffiliated with the issuer, without the issuer’s involvement.

The tokenized security must represent actual underlying shares; synthetic products that merely provide exposure to an underlying security (e.g., tokenized linked securities and tokenized security-based swaps), as well as rights and warrants, cannot trade on a TSV. The tokenized stock must convey the same rights and privileges as the equivalent non-tokenized NMS stock, including dividends, voting and share of residual assets; a third-party tokenizer must make proxy materials and communications from the underlying company available to holders of the tokenized stock at no cost to the company or shareholders.

The SEC is soliciting public comment about possible modifications to the relief and potential next steps – but the TSVs can rely on the relief right now. That means that even if your company has no interest in tokenizing its own securities, you may receive a notice that a third party wants to do so. As this Covington memo explains, public companies have an opportunity to object to that:

A TSV seeking to trade a tokenized stock must provide written notice to the issuer at least 30 calendar days before trading commences, providing the issuer with an opportunity to object. TSVs are required to send the notice to the physical or email address for the issuer’s principal executive offices listed on the cover page of its Exchange Act reports, and include the TSV’s current, accurate contact information.

Companies that wish to object must provide written notice of objection to the TSV. Third party tokenized stock must have the same economic and governance rights of listed stock (i.e., the right to dividends, residual assets, and vote). The order does not permit any primary issuance or initial offerings on a TSV; companies should not, at this stage, view tokenizing securities as a capital raising opportunity, unlike the SEC’s recent Regulation Crypto Assets proposal.

The Covington team also walks through how the TSVs operate, open questions that are not addressed in the SEC order, potential benefits and risks of tokenized securities, and next steps. If, like me, you are wondering how the tokens get issued in the first place, the Gibson team addresses that, along with other mechanics and impacts:

– More than 13,000 public issuers of Reg NMS securities are potentially impacted. Timely objecting to the Issuer Notice is the only way for an issuer to prevent a TSV from making a third party’s tokenization of its securities available for trading.

– Third-party tokenization will require the offer and sale of those tokens to be registered under the Securities Act or qualify for an exemption from registration. Currently, third-party issuers of tokenized U.S. publicly registered equities are offering and issuing those securities abroad – for example, in the Abu Dhabi Global Market or the Island of Jersey, typically in reliance on Regulation S. Although the Order provides a pathway for secondary trading on a TSV, it does not itself provide Securities Act relief for the creation or distribution of the tokenized security, calling into question whether structures currently used for offshore tokenized equities can be replicated for U.S. investors.

– Trading on a TSV can be made available directly to retail investors without an intermediary, and those investors may self-custody the securities in their own digital wallet.

– The TSV Exemption attempts to encapsulate many of the regulatory provisions for oversight of national securities exchanges, broker-dealers and alternative trading systems through limited reporting and recordkeeping requirements and extensive disclosure requirements. In this regard, the Commission is returning to first principles, relying on disclosure to inform investors and markets of risks and potential benefits of trading on TSVs.

– A TSV must be a U.S. person required to comply with OFAC-administered sanctions requirements and maintain access-permissioning procedures, including identity verification and wallet controls, designed to address OFAC sanctions and applicable AML/CFT requirements.

– Under the TSV Exemption, TSVs are not subject to the fair access requirements applicable to registered national securities exchanges and ATSs, and accordingly may set their own permissioning criteria to determine which persons may access trading on the TSV—including by denying or limiting such access—and may differentiate among TSV Participants with respect to access, trading procedures, market data, and fees, with such denials, limitations, or differences in treatment not being subject to SEC review.

There are a few things that public companies can do right now to prepare for “innovations” in their securities. Check out my next blog to get started.

– Liz Dunshee