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Financial Supervisory Commission Announced that Securities-type Virtual Currency Belongs to Negotiable Securities under the Securities and Exchange Act

Charlotte S. H. Wu, Partner, Zhong Yin Law Firm

 charlotte.wu@zhongyinlawyer.com.tw

The Financial Supervisory Commission announced today (3 July 2019) that virtual currency with securities nature falls under the category of negotiable securities under Article 6 of the Securities and Exchange Act if they comply with the nature of liquidity and investment. (Refer to《Order No. Financial-Supervisory-Securities-1080321164 of the Financial Supervisory Commission》[2])

According to the administrative rule of the Financial Supervisory Commission, virtual currency must comply with the following points in order to be regarded as securities:

  1. Virtual currency: Refers to the use of cryptographic method and distributed ledger technology or other similar techniques to digitally recognize the value of its storage, exchange or transfer.
  2. Liquidity
  3. Investment: To determine whether virtual currency possesses investment value, it is necessary to further investigate whether it complies with the following requirements:
  4. Contribution made by a funder.
  5. Contributes to a common enterprise or plan.
  6. Funder has expectations to gain profit.
  7. Profit is determined by the effort of the issuer or a third party.

Brief Introduction of the Framework of the U.S. Securities and Exchange Commission on Digital Assets

Referring to the《Framework for “Investment Contract” Analysis of Digital Assets》guideline [3] (Announced on 30 April 2019) published by the U.S. SEC. According to that guideline, under Federal Securities Law, securities include investment contract. As for digital assets, for instance, to determine whether or not ICO constitutes an investment contract and is subject to the Federal Securities Law, it is necessary to examine and see if it complies with Howey Test. According to the explanation of the guideline, the following conditions are included: 

  1. The Investment of Money: Meaning the digital asset can be purchased or exchanged in the form of legal money, physical currency or other digital asset or consideration. Referring to the opinion of the SEC in The DAO, as long as the content of the contribution has value, then it fulfills the requirement of an investment contract [4], even if the digital asset lacks consideration. However, if it is distributed through “Bounty Program”, then it may still matches the conditions of monetary investment and constitutes an investment contract.[5]
  2. Common Enterprise: Although the opinion of the Federal judiciary of the United States on determining common enterprise, is that it must have horizontal commonality or vertical commonality. However, the SEC discovered that with regards to the situation of digital assets, there is usually a common enterprise, as for whether or not is has horizontal or vertical commonality, it is not an important factor.
  3. Reasonable expectations for profit due to the efforts of others.

1. Depending on the efforts of others: It mainly involves two key issues. One is whether the subscriber has reasonable expectations from relying on the efforts of others? The second is whether the efforts of other middle managers are the undeniable significant ones that affect the success of the common enterprise, and are the critical factors that determine the success or failure of the business. In addition, SEC gave examples of situations where the relying of others exist in the guideline. The more it matches the the situation, the more it fits the requirement. For example, having basic tasks and duties executed by the active participants, AP, or planned to be executed by them, and not by distributed network.

2. Reasonable expectations for profit: Similarly, SEC gave examples of situations that constitute reasonable expectation. The more it matches the the situation, the more it fits the requirement. For example, digital assets may be transferred or traded through secondary market or platform, or are expected to be transferred or traded in the future; digital assets give the holder the right to share the proceeds of future business revenue, profits or earnings etc.

3. Other related factors to consider: The above mentioned two conditions in the guideline are positive examples, the more it matches the situation, the more it constitutes an investment contract. Yet the guideline also provides negative examples of how the possibility of tallying with the investment contract may be lowered in certain circumstances. For example, The holder of digital assets can immediately use the expected function provided on the network, especially the incentives built into the network to encourage holders to use; The creation and the structure of digital assets are designed to meet the needs of users, and not for the speculative purpose of value or network development. 

Questions and Discussions

Overall looking at the points above, there are still considerable differences between the requirements of adding crypto assets to the securities law in Taiwan and in the United States. Among them, though the investment requirements in Taiwan modeled the ones in the States, there are still differences, waiting for us to further explore and clarify. For example, taking a look at the “investment” nature of virtual currency:

First, determining the “contribution” of funder:

According to the meaning of the text, the scope of “funding” is broader than that of “money”. However, the Federal judiciary of the United States has already expanded its scope of application for the “investment of money” with regards to investment contract. Pursuant to the Company Act, due to the principles of asset adequacy and stability, there are certain limitations for the types of contribution from shareholders or investors, for example, cash, labour, technology, money claim and other rights [6]. However when it comes to the “contribution” of virtual currency, is it necessary to adopt the same explanation? For example, if an investor offers to buy securities-type crypto token with “credit”, does it still fits the requirements of investment and is subject to Securities and Exchange Act? This question is worthy of discussion. 

Second, Funder’s expectation for profit:

Does funder’s expectation for profit consider reasonableness? Is is covered too broadly if the mere subjective expectation of the funder is considered as investment? Furthermore, for profits that are gained from the efforts of others, is it necessary to consider that the funder is aware of this and can develop reasonable expectation from it? Is it necessary to consider that the behavior of the issuer or other third party objectively causes investors to expect profit from their efforts?

Third, the profit is mainly determined by the efforts of the issuer or the third party:

Regarding the judgement of “mainly”, should it refer to the explanation of the “main” part of business or property in Article 185, Paragraph 1-2 of the Company Act, that is, it must be “enough to affect the success or failure of the business of the company”[7]? If “profit” is determined by the efforts of the issuer or the third party, then in explanation, does it include the critical and undeniable factor of the issuer or the third party on the “success or failure of the investment business”?

Many have been talking about technologies such as crypto assets and blockchain. People often overestimate the devolvement within two years, but underestimate the effect after ten years. It is apparent that the combination of new technologies and the industry takes time and the process of trial and error to learn and improve, in order to become fully developed. The unknown and uncertainty brought by new technology is a common issue faced by both industries and government regulators. This article expects more discussions and adjustments on the perspective of new technologies when existing law applies to crypto assets.

【This article is for your reference only, and is not meant to provide any investment advice. You are welcome to contact our firm should you need legal counsel: Charlotte Wu, Attorney-at-law: email: charlotte.wu@zhongyinlawyer.com.tw

*Please respect the intellectual property rights by citing the web source and author, or send an email to the author

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[1] According to the Criminal Judgment Tai-Shan-Zi No. 3215 of the Supreme Court in 104, “the “securities” regulated by the Securities and Exchange Act, … should take into account the basic definition of Article 6 of the Act, and the nature of securities under the Securities and Exchange Act, that is, it should focus on whether or not it ‘recognizes a certain value’ and has ‘investment’ purpose and ‘liquidity’”.

[2] Financial Supervisory Commission, issued the order that securities-type virtual currency belongs to the securities mentioned in the Securities and Exchange Act. (Order No. Financial-Supervisory-Securities-1080321164 of the Financial Supervisory Commission), July 3 2019, https://www.fsc.gov.tw/ch/home.jsp?id=128&parentpath=0,3&mcustomize=lawnew_view.jsp&dataserno=201907030002&aplistdn=ou=newlaw,ou=chlaw,ou=ap_root,o=fsc,c=tw&dtable=NewsLaw(last viewed:07/05/2019)

[3] SEC, Framework for “Investment Contract” Analysis of Digital Assets, Apr.3, 2019, https://www.sec.gov/files/dlt-framework.pdf (last visited: July 5,2019).

[4] SEC v. Shavers, No.4:13-CV-416, 2014 WL4652121, at *1 (E.D. Tex. Sept. 18, 2014)(Believes crypto currencies such as Bitcoin, matches the conditions of monetary investment in the Howey Test); Uselton, 940 F.2d at 574 (Believes that the “money” in investment can be “product or service”, or other things with exchange of value).

[5] See In re Tomahawk Exploration LLC, Securities Act Rel. 10530 (Aug. 14, 2018) (issuance of tokens under a so-called “bounty program” constituted an offer and sale of securities because the issuer provided tokens to investors in exchange for services designed to advance the issuer’s economic interests and foster a trading market for its securities).

[6] Article 41, 43, 99-1 of the Company Act.

[7] Judgement Tai-Shan No.81 of the Supreme Court.