[In]Securities Guest Blog: tZero/No Limit by Aegis Frumento Esq

September 25, 2020


tZero/No Limit

In 1981, Sear Roebuck & Co. bought Dean Witter & Co. Buying brokerage firms was a thing back then. Prudential Insurance bought Bache Halsey; American Express had bought Shearson. They, at least, were already in the financial business. But the news that the country's largest retailer was looking to become the nation's one-stop-shop financial superstore was widely derided at the time. "Socks and stocks," the market sophisticates mocked.

Sears actually had been a major player in finance for a century. Sears grew on credit that it itself provided to its customers. Its internal bank financed most major purchases from the store almost from the start. That peaked in the early 20th century when Sears financed the sale of its kit houses, becoming one of the country's largest mortgage lenders. That experience ended badly. During the Depression, Sears had to foreclose on many of its customers' homes. See http://www.brokeandbroker.com/4255/frumento-sears/.

But Sears wasn't all crazy to think it could combine a department store with a securities firm. Sears acquired Dean Witter a scant 6 years after May Day -- May 1, 1975 -- the day fixed brokerage commissions on stock sales were abolished. Many then predicted that competition would inevitably drive brokerage commissions down to commodity levels, a meteor that would do in the dinosaur wirehouses. I don't know, but I would guess, that some executives at Sears, predicting that stocks and socks would soon sell at the same profit margin, rated themselves geniuses for thinking they could be shelved in adjoining aisles. Such is the power of (absolutely) positive thinking.

That all ended badly too. What socks and stocks don't have in common dwarfs whatever they do. A sock is a sock is a sock, and if you buy a bad one, there's little at stake. On the other hand, one stock is not another, and the money lost on a bad trade can buy a lot of socks. Sears sold Dean Witter to Morgan Stanley in 1997, which despite the blue chip on its shoulder, had long lusted for a retail brokerage through which to peddle its growing stable of tech stock IPOs. That the aristocrats at Morgan's investment bank tended to condescend upon the Dean Witter stock jocks is another story. But for Sears, its adventures in market finance began a long distraction that allowed competitors like Walmart and Amazon to eat the last crumbs of its lunch. It filed for bankruptcy protection in 2018.

So what, then, should we make of the news that Overstock.com, an online purveyor of stuff in the great Sears tradition, has formed its own retail broker-dealer? Overstock's tZero just won FINRA approval of a retail broker-dealer subsidiary that will specialize in brokering securities that trade as cryptosecurities on a blockchain. It will launch operations in a few months. https://www.businesswire.com/news/home/20200910005626/en/tZERO-Approved-to-Launch-Retail-Broker-Dealer-Subsidiary. Is this another Sears trying to tie together products that don't mix? Why should we expect Overstock/tZero to succeed where Sears/DeanWitter failed?

Because timing is everything. Despite appearances, history is not repeating itself. In this case, it is not even rhyming.

Modern business seems to be all about misdirection. A company sells itself as an online-bookstore and evolves into an internet infrastructure utility company. Overstock began selling discount home furnishings. It still does, just like Amazon still sells books. But about 6 years ago, Overstock began slowly to morph into a cryptocurrency enterprise. In 2014, it was the first major retailer to accept payment in bitcoin. tZero, its alternative trading system for institutional transactions in securities, facilitated the first recorded trade in a registered cryptosecurity in 2016. For that matter, Overstock itself issued its Preferred Digital Dividend Shares at cryptosecurities. The creation of a retail broker-dealer subsidiary to allow non-institutional traders to buy and sell cryptosecurities is the next logical step in filling out a cryptosecurities ecosystem. 

Here's another way that Overstock and Sears are dissimilar. Sears bought Dean Witter as a firm in full. Overstock is playing in a Field of Dreams, betting that if it builds it, they will come. It's not a bad bet; it's the same bet Amazon made. But Amazon's bet paid off because no one else (like Sears) was sharp enough to do the same thing. They abandoned the field to Amazon until it was too late to catch it. I'm not so sure that tZero's future will be as clear.

We are still very early in this game. There aren't very many cryptosecurities out there to be traded. The tZero ATS only lists 3, and 2 of them are Overstock and tZero's prop fund. And yet, already tZero has competitors. For example, Securitize.io is a registered transfer agent, and in that capacity offers to facilitate cryptosecurities transactions on the blockchain it manages. https://www.securitize.io/. It, too, only has a few cryptosecurities on its ledger. Another similar venture, InvestaX.io, operates out of is and is licensed in Singapore, and offers secondary market trading in non-public cryptosecurities. https://investax.io/. I'm sure there are others, and will be more, because the costs of setting up such a business are not all that great. All firms that manage cryptosecurities on a blockchain are more similar than they would like to admit.

So, tZero should not assume it has the field to itself. Its name is in the forefront to be sure. But that's today, and no assurance that a bigger fish won't come along tomorrow. And yet, the business that it anticipates may well have no limit. The cryptosecurities industry will be so large -- as large as the traditional market and then some -- that there will be room for many players. The advantages of using a blockchain instead of a broker/exchange/clearing firm/transfer agent/custodian to effect a stock sale are too obvious to ignore. Cryptosecurities will fulfill the ultimate promise of May Day to drive transaction costs down to practically Zero, which is, of course, exactly what the "tZero" name connotes. Zero usually means failure, but in this case there'll be no success like it. 


Aegis J. Frumento

380 Lexington Avenue
New York, NY 10168

Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters.  Mr. Frumento also represents clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents. Those now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises.

Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.

He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of BrokeAndBroker.com Blog.

[In]Securities Guest Blog: tZero/No Limit by Aegis Frumento Esq (BrokeAndBroker.com Blog)

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