What Does Blockchain Mean for Dispute Resolution?

Antitrust and Competition

Disputes involving antitrust commonly involve collecting industry data from a myriad of different companies that keep their data with varying degrees of rigor. The blockchain could result in a single data collection point with information stored and recorded in a systematic and cohesive way. For example, if all grocery stores sourcing fresh produce used the same blockchain to track produce and prices from farmers through to consumers (even if for the purpose of tracking by the Centers for Disease Control of salmonella outbreaks), collection of data for an antitrust investigation involving grocery stores would become much simpler.

Market Manipulation

Disputes involving market manipulation claims in over-the-counter (OTC) markets without a single centralized exchange (e.g., foreign exchange options, physical crude oil transactions) often involve expensive and complex data collection and analyses. A centralized and distributed ledger for transactions could provide a more comprehensive, accurate repository of market transactions at a lower cost. In his keynote address at FinTech Week on November 7, 2018, the chairman of the Commodity Futures Trading Commission (CFTC), J. Christopher Giancarlo, discussed the possibility of blockchain technology facilitating the OTC swap reporting regime, which would feed into the CFTC’s market monitoring and enforcement efforts.

Disputes often involve econometric analysis to assess whether market prices reflect the fundamental forces of supply and demand and whether price changes are consistent with changes in liquidity and information. A blockchain-based data source could be a powerful tool to assess whether actual prices differ significantly from “but-for” prices (i.e., prices that would have prevailed absent the alleged wrongdoing). For example, if a series of trades are alleged to be manipulative, how would their impact be calculated? A frequently used analytical technique is to model the evolution of the market price when the allegedly manipulative trades took place and assess what would have happened “but for” the conduct. The additional information brought by a transparent blockchain-based data source would facilitate assessment of the impact of the alleged conduct, including whether it resulted in artificial prices.

Although a powerful data source, a blockchain may not be able to distinguish between price changes caused by new information about the physical market and developments in the trading market. Any blockchain information may still need to be supplemented by information from other sources to conduct analysis of market manipulation.

Class Actions and Proxy Voting

Certification of the bulk of class actions requires a convincing argument that damages to potential class members can be calculated using a common methodology. In general, a class will not be certified if individualized inquiry is required to determine which class members were injured. For example, recent rulings against class certification in residential-mortgage-backed securities cases have found that determining the relevant ownership history of the relevant securities was impossible in some situations and required highly individualized inquiry. Distributed ledger blockchain technology that cleanly tracks ownership may alleviate the need for individualized inquiry in some instances.

Participants in the securities markets have been debating the role that blockchain may or may not play in the record keeping and “tracing” of shares. Under the current system, most shares are held in “street name,” meaning that a depository, not the investor, is the owner of record. Investors are “beneficial owners,” receiving the economic benefits of ownership by virtue of having a claim known as a “securities entitlement” against an intermediary, such as a broker or bank, that in turn holds an entitlement against the depository. See Russell A. Hakes, “UCC Article 8: Will the Indirect Holding of Securities Survive the Light of Day,” 35 Loy. L.A. L. Rev. 661 (2002). These entitlements are not claims to specific earmarked shares, and they are not necessarily even backed by shares held by the intermediary. When shares change hands due to trade settlements, bookkeeping entries are made at the depository and on the intermediary’s books, but there is no change in record ownership. This makes it difficult, if not impossible, to “trace” shares held in investor accounts backward in time to determine whether the shares are “traceable” to a particular offering.

This has important implications for securities litigation, where legal standing for some categories of claims requires tracing. Moreover, if the intermediary lends out shares, the beneficial owner still holds a claim against the intermediary even though the intermediary no longer holds shares at the depository. As a result of stock lending and short selling, the number of shares held by beneficial owners generally exceeds the number of shares outstanding. This creates logistical challenges for the proxy voting process. See Sec. & Exch. Comm’n, Concept Release on the U.S. Proxy System, Release No. 34-62495 (July 14, 2010).

In principle, these issues may be addressed if the existing system were replaced with an alternative record-keeping system that tracks ownership at the level of the beneficial owner, a move that might be facilitated by blockchain technology. An open question is whether such a fundamental change in the legal structure of ownership would be feasible and the extent to which it might undermine the efficiencies associated with the current net settlement system.

Other proponents of blockchain have discussed how proxy voting complexities may be improved by using blockchain technology. Vice Chancellor J. Travis Laster of the Delaware Court of Chancery gave a speech entitled “The Block Chain Plunger: Using Technology to Clean Up Proxy Plumbing and Take Back the Vote,” in which he discussed various options to use blockchain technology in proxy voting. A recent Barron’s article, “Three Proxy Votes That Went Bad” (July 6, 2018), described other examples of potential concerns with proxy voting complexities. One of the examples included T. Rowe Price Group’s unintentional vote for Michael Dell’s bid to take his computer company private when T. Rowe Price Group was actually opposed to the private takeover. Another example was Taser’s 82 million proxy votes cast when the company only had 61 million shares outstanding, which resulted from rampant short selling and votes received from both lenders and borrowers of the stock. The final example involved a vote by Procter & Gamble (P&G) shareholders against an activist hedge fund, Trian Fund Management, and its chief executive officer (CEO). P&G ultimately invited the CEO to the board because the vote counts were so close. However, millions of votes were apparently invalidated and not counted due to complications from using Internet systems, mismatched voter names, and other synchronization issues with ballot and proxy paperwork. Depending on the blockchain technology implemented, some of the complexities related to proxy voting may be alleviated because ownership could be recorded in one location and voting could be done on the blockchain.

Class Action Settlements

Many class actions are resolved by settlement where defendants agree to pay plaintiffs a lump sum. That payment needs to be distributed to all named and unnamed plaintiffs in the suit—often numbering in the thousands of plaintiffs. The process of identifying and contacting all plaintiffs and ultimately distributing the settlement amount can cost hundreds of thousands of dollars because entities use different data collection systems and the end investor is often difficult to identify. Just determining the addresses of the parties to notify is an expensive process. Blockchain technology may alleviate such costs by keeping an end-to-end record of all entities that would be considered plaintiffs in a class action.

Conclusion

Blockchain has the potential to change dispute resolution as much as electronic discovery did. Centralized and distributed ledgers of market and financial data may allow for more efficient collection and analyses of crucial data in a variety of disputes.

Nicole Moran is a principal with Cornerstone Research in its Washington, D.C., office.

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