Disclosure is all we need

Columbia law professor Tim Wu argues that every kind of economic transaction relies first and foremost on buyers feeling informed. People want to know that what they’re buying is of reasonable quality, that the price is approximately right, that they’re not being bamboozled. In Wu’s telling, intermediaries that aggregate information and create trust between strangers emerge to solve this problem, making transactions possible at scale. EBay, for example, is a good place to buy high-priced baseball cards because of all the information it offers on sellers.

“Probably the most successful example is the stock market,” Wu says, “which gives people enough comfort that they’re willing to buy what is basically a piece of paper that supposedly says you own part of a company.”

Why do we trust these pieces of paper? It's not, as you might assume, the law. Shareholders only have legal rights of ownership in cases of bankruptcy and takeovers, so Wu is correct to cast aspersions on the idea that owning shares makes you part owner of a company. 

If anything, a close reading of corporate law should make us distrust the stock market. Thanks largely to the business judgement rule, company executives are free to do just about whatever they want with the capital we give them 

But we’ve come to trust them to do the right thing — to treat us as if we own the company.

This was a process that took many decades. And it began with disclosures.

In 1899, a congressional investigator asked Henry O. Havemeyer, the robber baron head of the Sugar Trust, whether investors had any right to know what they were buying on the stock market. His response captured the spirit of 19th-century investing:

Commissioner: “You think then, that when a corporation chartered by the State offers stock to the public, and is one in which the public is interested, that the public has no right to know what its earning power is or to subject them to any inspection whatever, that the people may not buy stock blindly?”

Havemeyer: “Yes, that is my theory. Let the buyer beware. That covers the whole business.” 

At the time, it was virtually unheard of for companies to reveal much of anything about their operations. Disclosure was seen mostly as a competitive risk.

But “buyer beware” is no way to run a market of any kind, let alone a stock market, where people are asked to entrust their life savings to strangers.

A contemporary banking journal lamented that “so many people have lost their money on ‘fake’ investments that they seem to be incapable of distinguishing the false from the genuine, and hence are distrustful of all.”

By 1900, however, the stock market was just starting to get important. In that year, there were only about 500,000 shareholders in the US. Most companies were still run by the people who owned them.

But the Second Industrial Revolution was creating much larger corporations — far too large to be funded by a handful of manager-owners. To attract outside capital, big corporations knew they’d have to start sharing more information.

US Steel was the first, taking the radical step of publishing detailed financial statements in 1901. It had little choice because J.P. Morgan needed to sell hundreds of millions of dollars of securities to assemble the conglomerate he had financially engineered. Raising an unprecedented amount of capital required unprecedented transparency.

Few companies immediately followed suit. But by 1910 the New York Stock Exchange had standardized US Steel-like disclosure by requiring that listed firms publish annual reports and quarterly income statements and mandating that shareholders be given prior notice of share issuance and changes to dividends.

This marked the end of 19th-century investing. “The doctrine of caveat emptor,” one study concludes, “was now void and corporate nondisclosure was no longer acceptable.” 

It worked. By 1930, an estimated 10 million Americans owned stocks.

In 1933, disclosure became the law of the land with the passage of the Securities Act. In 1934, the SEC was established to codify and police those disclosures.  

Shareholders were granted no new rights of ownership, however. Shares remained, in Professor Wu’s phrase, pieces of paper.

But they did win an enforceable right to information — the first and most important step to establishing trust in a market.

Trusting tokens

Today, Blockworks launched the Transparency Alliance, an industry group aimed at establishing trust in the market for tokens by adopting a standardized set of disclosures.

“Crypto has entered its institutional era,” Blockworks co-founder Jason Yanowitz said. “But tokens can't progress until the market trusts them again.”

This is timely because the halcyon days of tokens routinely achieving multibillion-dollar valuations based on memes and vibes appear to be over. If crypto is going to build anything in this new institutional era, it will have to earn the trust of more traditional investors. Disclosure is the first and most important step in that direction. 

It’s not the only step. From the NYSE establishing transparency standards in 1910, it took about 80 years — until the Gordon Gekko-era of leveraged buyouts — for US companies to truly treat their shareholders like owners.

But everything happens faster in crypto, so there’s no reason to think it will take that long this time around.

In fact, it may already be happening. Felipe Montealegre of Theia Research says “we underwrite meaningfully higher valuations for companies with outstanding B1s/B2s, and so do other investors.”

B-1s and B-2s are Blockworks’ crypto equivalent of the SEC’s forms S-1 and S-2, which are the basic building blocks of trust in stock markets.

To paraphrase Professor Wu, the goal is for these to give investors enough comfort to treat tokens as if they are real assets.

NYSE and the SEC made it work for stocks. 

The Transparency Alliance should make it work for tokens, too.

— Byron Gilliam

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