Tuesday 8 May 2018

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.

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