Extra-territorial application of Japanese law to ICOs: Payment Services Act

Japanese law currently has no specific regulations for ICOs. But Japan's financial watchdog, the FSA (Financial Services Agency) issued an open letter of warning, stating its view that "ICOs may fall within the scope of the Payment Services Act and/or the Financial Instruments and Exchange Act depending on how they are structured." (October 27, 2017). Since we have examined the Financial Instruments and Exchange Act in the last post, we will now turn to the Payment Services Act to see the extent of its geographical outreach.

The Payment Services Act regulates the "exchange services of virtual currencies" by imposing registration and other requirements for providing the services (Article 63-2, etc.). It defines the concepts of "virtual currencies" (Article 2(5)) and "exchange services of virtual currencies" (Article 2(7)). At the time of writing, it is uncertain whether any tokens issued in ICOs are deemed to be "virtual currencies." We will assume, for the sake of the following analysis, that some of them will be so deemed. The "exchange services of virtual currencies" signifies carrying out any of the conducts listed in Article 2(7) "in the course of trade", a phrase which is usually interpreted as implying repeated and continuous conducts. The listed conducts include the sale and purchase of virtual currencies and exchanging between different virtual currencies. Thus, cryptocurrency exchanges, or entities so called, will generally be seen to be providing "exchange services of virtual currencies." Some commentators seem to believe that the issuers of ICO tokens (if deemed to be "virtual currencies"), too, provide "exchange services of virtual currencies" on the basis that ICOs would involve the purchase of tokens (deemed ex hypothesi to be "virtual currencies") or exchanging them with other virtual currencies. But I doubt the correctness of this interpretation since the issuance of ICO tokens can hardly be described as repeated and continuous conducts. The appropriateness of such interpretation is also doubtful since the issuer of ICO tokens, if treated as a provider of "exchange services of virtual currencies", would be subject to disproportionately heavy duties of compliance. The Payment Services Act also contains the definition of "foreign provider of exchange services of virtual currencies": it refers to any person who pursues the "exchange services of virtual currencies" in a foreign country who has effected registration of the same kind as required under Article 63-2 (or has received other similar administrative authorization such as a permission) pursuant to that country's statutes or statutory instruments which are equivalent to the Act (Article 2(9)). Even if the words "other similar administrative authorization" are construed broadly, it would be rare for any ICO issuers operating from outside Japan to have received such authorization. It follows that although the following analysis - which concerns the "foreign provider of exchange services of virtual currencies" - will be relevant to some of the foreign cryptocurrency exchanges dealing in ICO tokens which are deemed to be "virtual currencies", its relevance to the issuers of such ICO tokens operating from outside Japan is doubtful.

The Payment Services Act provides at Article 63-22:
The foreign providers of exchange services of virtual currencies who are not registered pursuant to Article 63-2 shall not make solicitations aimed at persons located in Japan with respect to any conducts listed in the sub-paragraphs of Article 2(7).
(Annotation: Article 63-2 prohibits any person to pursue the "exchange services of virtual currencies" without registration. Article 2(7) lists the conducts which, if carried out "in the course of trade", would constitute the "exchange services of virtual currencies".)

The FSA published "Administrative Guidelines" for the providers of "virtual currency exchange services". It contains a sub-chapter concerning the treatment of the "foreign provider of exchange services of virtual currencies" (II-４: Framework of Analysis for Foreign Providers of Exchange Services of Virtual Currencies). So far as I am aware, the FSA has not published an English translation of those guidelines. For the convenience of foreign readers, I have translated the text (below).

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II-4 Framework of Analysis for Foreign Providers of Exchange Services of Virtual Currencies

II-4-1 Prohibition Against Solicitation by Foreign Providers of Exchange Services of Virtual Currencies
Foreign providers of exchange services of virtual currencies (excluding those who have been registered pursuant to the applicable law. Ditto under II-4-2 below.) shall not make solicitations of transactions involving their services with persons located in Japan, save to the extent otherwise stipulated by statutes or statutory instruments.

II-4-2 Cross-border Transactions Using Internet by Foreign Providers of Exchange Services of Virtual Currencies
Where a foreign provider of exchange services of virtual currencies posts on its website or elsewhere on the internet advertisements or other contents concerning transactions involving their services, it shall in principle be deemed to be a “solicitation.”
It shall, however, not be deemed to be a “solicitation” aimed at persons located in Japan if reasonable measures are taken to prevent the advertisement or other contents from resulting in transactions with such persons, the prime examples of such measures being those detailed below.

(1) Disclaimer
The disclaimer must clearly state that the exchange services are not targeted at persons located in Japan.
In judging whether the above measure is adequately taken, it is necessary to have regard to the following points:
(i) whether the disclaimer is legible simply by viewing the advertisement or other contents without any additional operations on the computer terminal required; and
(ii) whether the disclaimer is written in a language which it would be reasonable to expect the persons accessing the website in Japan to understand.

(2) Measures to Prevent Transactions
These are measures implemented to avoid concluding transactions involving the exchange services of virtual currencies with persons located in Japan.
In judging whether such measures are adequately taken, it is necessary to have regard to the following points:
(i) whether a procedure is put in place whereby the whereabouts of the users can be checked at the time of transactions by requiring them to present their details such as their place of domicile, postal address, e-mail address and their chosen method of payment;
(ii) whether care is taken to avoid accepting orders for transactions involving the exchange services of virtual currencies where there are reasonable grounds to believe that they have been obviously sent from persons located in Japan; and
(iii) whether care is taken to avoid inducing persons located in Japan to engage in transactions involving the exchange services of virtual currencies by, for example, refraining from establishing in Japan a call center for users or creating links from web pages which are targeted at persons located in Japan.
The above-mentioned measures are illustrative only. If measures which are equivalent or more effective are implemented, the posting of advertisements or other contents shall not be deemed to be a “solicitation” aimed at persons located in Japan.

(3) It should be noted that where reasonable measures, such as those detailed above, are not implemented, the posting of advertisements or other contents on the internet is highly likely to constitute a “solicitation” of transactions involving the exchange services of virtual currencies aimed at persons located in Japan. Such being the case, the foreign provider of exchange services of virtual currencies should prove that it is not engaged, by way of solicitations, in transactions involving the exchange services of virtual currencies with persons located in Japan.

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What is stated under II-4-1 is only a reiteration of Article 63-22 of the Payment Services Act (See above). It is worth noting that what foreign providers are prohibited to do is the solicitation of transactions aimed at persons located in Japan: Concluding unsolicited transactions with such persons is not prohibited unless it is done "in the course of business" (hence repeatedly and continuously) in violation of Article 63-2. However, II-4-2 gives a broad interpretation to the notion of "solicitation aimed at persons located in Japan" as it states that the posting of an advertisement on the internet is highly likely to constitute such a solicitation unless reasonable measures are implemented to prevent transactions with persons located in Japan. Moreover, it places the onus on foreign providers to prove that they are not engaged in such solicitations.

Extra-territorial application of Japanese law to ICOs: Financial Instruments and Exchange Act

Japanese law currently has no specific regulations for ICOs. But Japan's financial watchdog, the FSA (Financial Services Agency) issued an open letter of warning, stating its view that "ICOs may fall within the scope of the Payment Services Act and/or the Financial Instruments and Exchange Act depending on how they are structured." (October 27, 2017).

Thus, where an ICO scheme is deemed to be a "collective investment scheme" as defined (without using that expression) by Article 2(2)(v) of the Financial Instruments and Exchange Act, the ICO issuer would be subject to the registration and other requirements under the Act (Article 29, etc.). Leaving aside the question what types of ICO schemes are so deemed, we will focus in this post on the transnational reach of the Financial Instruments and Exchange Act (We will turn to the Payment Services Act in the next post). A question of particular significance is how far that Act is applicable to ICO issuers operating from outside Japan.

The FSA published "Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, etc.", of which the latest version is dated April 2018. It contains a sub-chapter concerning the treatment of foreign securities companies (X-1: Basic Concept for Foreign Securities Companies). There is an English translation by the FSA of the February 2017 version of the Guidelines. No difference exist in substance between the two versions, so far as the sub-chapter on the treatment of foreign securities companies is concerned.

Is this sub-chapter relevant to ICOs? Under the Financial Instruments and Exchange Act, "foreign securities companies" are persons who, in accordance with foreign statutes or statutory instruments, pursue the securities services in a foreign country. (Article 58). Under the same statute, the "securities services" are defined (in Article 28(8)) to include the handling of a public offering of securities but does not include a public offering per se (See sub-paragraph (viii) of Article 28(8)). It follows that even if some ICO schemes were deemed to be securities, the issuers of such ICOs would not be subject to the aforementioned sub-chapter on the treatment of foreign securities companies. Consequently, we are devoid of guidelines directly applicable to ICO issuers with respect to the geographical outreach of the Financial Instruments and Exchange Act. The sub-chapter, however, will be relevant to the "securities services" concerning ICO tokens, such as the handling of an ICO, the secondary distribution of ICO tokens and the handling of the secondary distribution.

Change of the blog title

I have changed the title of this blog from "Blockchain and Cryptocurrency Law" to "Blockchain, Cryptocurrency, Crypto-asset and the Law."

The change reflects the growing profile of non-currency crypto-assets. Crypto-currencies are species of crypto-assets but are mentioned separately in view of their importance as a category of their own.

Private actions under the federal securities Acts of the United States: Availability in cross-border ICO cases

We have examined the registration requirement in a previous post and the anti-fraud provisions as enforced publicly by the SEC or DOJ in the last post. In this post, we will turn to private rights of action (e.g. sections 11, 12, 15 and (impliedly) 17(a) of the Securities Act 1933 and (impliedly) section 10(b) and section 18 of the Securities Exchange Act 1934) to examine whether they are available in cross-border ICO cases.

The Supreme Court's ruling in Morrison v. National Australia Bank 561 U.S. 247 (2010) controls in private actions since the amendments introduced by the Dodd-Frank Act only concern public enforcement. The Supreme Court adopted the "transactional" test according to which section 10(b) of the Securities Exchange Act 1934 was only applicable to transactions in securities listed on domestic exchanges or domestic transactions in other securities.

It is a bright-line test so far as it relates to transactions on exchanges. But clarity is lacking with respect to off-exchange transactions. The Second Circuit subsequently held that a transaction was domestic where irrevocable liability was incurred or title passed within the United States. Concerning irrevocable liability, the Court found it sufficient if "the purchaser incurred irrevocable liability within the United States to take and pay for a security, or that the seller incurred irrevocable liability within the United States to deliver a security": Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 68 (2d Cir. 2012).

How will the Morrison test be applied to the transactions of ICO tokens? Since ICO tokens are traded on a borderless network, the place where title in them passes seems incapable of being localized in any specific jurisdiction. Then, where would parties incur irrevocable liability? In SEC v. PlexCorps (No. 17 Civ. 7007), responding to the defendants' motion which relied on the Morrison test, the SEC noted that the investors were irrevocably committed to purchase the ICO tokens by sending electronic communications into the defendants' automated system for the sales of tokens. The SEC further observed that those communications were deemed to have been sent from the investors' place of business pursuant to section 15(d) of the Uniform Electronic Transactions Act. This provision reads:

§15 TIME AND PLACE OF SENDING AND RECEIPT.
(d) Unless otherwise expressly provided in the electronic record or agreed between the sender and the recipient, an electronic record is deemed to be sent from the sender’s place of business and to be received at the recipient’s place of business. For purposes of this subsection, the following rules apply:
(1) If the sender or recipient has more than one place of business, the place of business of that person is the place having the closest relationship to the underlying transaction.
(2) If the sender or the recipient does not have a place of business, the place of business is the sender’s or recipient’s residence, as the case may be.

If the SEC's reasoning is accepted, ICOs would be deemed to take place within the United States for the purpose of the Morrison test where either the investors have their residence or the ICO issuer has its place of business within the United States at the time when the electronic communications are sent by the investors and received by the ICO issuer's automated system. The result would be like coming full circle to the "conduct" test after performing a lot of conceptual gymnastics. Let us wait and see what the court has to say.

Anti-fraud provisions of the federal securities laws of the United States: ICOs and extra-territorial jurisdiction

Having examined the registration requirement in the last post, we will now turn to the anti-fraud provisions (e.g. section 17(a) of the Securities Act 1933, section 10(b) of the Securities Exchange Act 1934 and Rule 10b-5 thereunder (17 CFR 240.10b-5), and section 206 of the Investment Advisers Act 1940). The SEC has started to invoke such provisions in ICO fraud cases (e.g. SEC v. PlexCorps, et al., No. 17 Civ. 7007).

Each of the above-mentioned Acts contains provisions which set forth the extra-territorial jurisdiction of the U.S. courts in cases involving the violation of the anti-fraud provisions. They are to be found in section 22(c) of the Securities Act 1933, section 27 of the Securities Exchange Act 1934, and section 214(b) of the Investment Advisers Act 1940. They commonly provide for jurisdiction over proceedings involving:

(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States (Note by the present author: The wording is different here in the Investment Advisers Act 1940 which reads "the violation is committed by a foreign adviser") and involves only foreign investors; or
(2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.

Those provisions were all inserted by the Dodd-Frank Act in 2010 which purported to restore the "conduct" and "effects" tests so far as the SEC or DOJ (Department of Justice) enforcement actions are concerned. The "conduct" and "effects" tests had earlier been rejected by the Supreme Court in Morrison v. National Australia Bank 561 U.S. 247 (2010) as being difficult to administer.

As formulated in those provisions, the first prong adopts a conduct test, while the second prong an effects test. The first prong will often be easy to apply but the second prong would require elaboration. In the particular context of ICOs, when will the effects within the United States be deemed foreseeable? Would it be necessary and/or sufficient for the ICO issuers to use non-English language in their ICO white papers or to block access from the IP addresses of the United States?

It is interesting to see whether any clarification will result from SEC v. PlexCorps. In this case, the SEC argued that the test was satisfied on its alleged facts because over 1,500 transactions had been concluded with investors located in the United States and because the defendants had purposefully directed their activities to investors in the United States by advertising their ICO tokens through social media and websites available throughout the United States, by using various U.S. based entities to obtain and process payments,and by marketing and selling their tokens in U.S. Dollars.

Registration requirement under the U.S. Securities Act 1933: Exemption for ICO offers made outside the United States

Since the publication of the DAO report ("Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO" (Release No. 81207)) last summer, the U.S. Securities and Exchange Commission (SEC) has been flexing its muscles to ensure that the securities regulations of the United States will not be flouted by ICOs (Initial Coin Offerings).

If an ICO issuer wants to avoid the registration requirement under section 5 of the Securities Act 1933, it has to come within one or more of the stipulated exemptions, one of which concerns offers and sales made outside the United States (Regulation S: 17 CFR 230.901 et seq). The making of Reg S in 1990 preceded the age of internet trading. In 1998, with the growing use of the internet, the SEC issued a note on interpretation (Interpretation Re: Use of Internet Web Sites To Offer Securities, Solicit Securities Transactions, or Advertise Investment Services Offshore). It purports to clarify when the posting of offering or solicitation materials on Internet Web sites would not be considered activity taking place "in the United States".

With the increasing activism of the SEC in the ICO sphere, clarifying its geographical outreach has become important. Reg S read in conjunction with the 1998 Interpretation, however, begs a number of questions as to how they are to be applied to ICOs. I have noted some such questions in the attached document here.


Many of these questions would equally arise in crowdfunding without blockchain tokens. But if the internet has increased the risk that foreign securities will flow back into the United States, the ICO tokens will aggravate the problem with their high mobility and anonymity in trading.