Bertrand C. Fry

Overstock.com, Inc., a public company listed on NASDAQ, announced on July 31, 2015 that it has completed the issuance of a $5 million “cyptobond” to FNY Managed Accounts LLC. Overstock.com has been at the forefront of the adoption and promotion of bitcoin, as well as the application of blockchain technology to securities transactions through its TØ.com trading platform. The issuance to FNY Managed Accounts, which is wholly owned by First New York Securities L.L.C., an SEC registered broker-dealer, follows Overstock.com’s issuance in June of a similar bond to its own CEO, Patrick M. Byrne. Mr. Byrne’s purchase of the $500,000 bond is frequently regarded as the first purchase of a security using a blockchain platform. Each of the newly issued bonds appears to be a “TIGRCub bond” – Top-Line Income Generation Rights Certificate – issued through Entrex.net as placement agent , which provide a structured investment exposure to the issuer’s top-line revenues in future years.

According to Overstock.com’s Form 8-K, filed on August 5, 2015, the ownership, principal payment, and any transfers of the newly issued bonds will be recorded on Medici Inc.’s TØ.com cryptosecurities trading system. Medici, Inc. is a majority-owned subsidiary of Overstock.com. The TØ.com platform is a public, cryptographically secured, distributed ledger system, more commonly referred to as a blockchain, which promises to permit simultaneous trade and settlement of securities transfers.

From the perspective of the U.S. securities laws, Overstock.com’s issuance is an unregistered private placement under Regulation D, which relies on the safe-harbor under Rule 506(c) to be exempt from the registration requirements of the Securities Act of 1933. Rule 506(c), which was introduced in 2012, opens a path for blockchain-based private placements like Overstock.com’s bond offering, because it permits an issuer to conduct a “general solicitation,” the SEC’s phrase for a public marketing effort, so long as the ultimate purchasers of the offered securities comprise only verified “accredited investors,” as defined for purposes of the Securities Act. Because a blockchain is publicly accessible, it would be difficult to conduct an offering over a blockchain as a private offering under Rule 506(b), the legacy private placement rule which requires (among other things) that the offering be conducted solely through private means, not involving a general solicitation.

Contrary to some commentators' analysis, only accredited investors under the Securities Act can participate in Overstock.com’s offering, and, in fact, the initial purchasers are expected also to be “qualified institutional buyers,” a type of investor identified in Rule 144A that are ultra-sophisticated.  Moreover, Overstock.com must engage in a satisfactory verification of each investor’s status as an accredited investor in order to rely on Rule 506(c). This verification does not appear to have been embedded into the blockchain, so there continues to be room for the evolution of the application of blockchain technology to private placements.