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.
Saturday, 12 May 2018
Friday, 11 May 2018
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.
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.
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.
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.
Tuesday, 1 May 2018
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.
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.
Monday, 2 April 2018
Activity-based Classification of Blockchain Regulatory Issues
In this blog, I have been primarily discussing private-law issues. But regulatory issues are no less important.
As public blockchains are borderless, activities on them may have to comply with regulations of multiple jurisdictions. The task is often difficult because of the diversity of regulatory approaches. One way to streamline and rationalize the regulations would be to move away from entity-based regulations (regulations based on the types of entities regulated) to activity-based regulations.
Here is my tentative compilation of blockchain regulatory issues classified according to the types of activities. It is not intended to be exhaustive. The lending and deposit-taking of cryptocurrencies, for example, are not included. An ICO (Initial Coin Offering) will involve both (1) Exchange with other tokens or fiat currencies and (5) Crowdfunding. (7) The trading of CBDC (Central Bank Digital Currencies) is not yet a reality but may come about at some point in the future.
As public blockchains are borderless, activities on them may have to comply with regulations of multiple jurisdictions. The task is often difficult because of the diversity of regulatory approaches. One way to streamline and rationalize the regulations would be to move away from entity-based regulations (regulations based on the types of entities regulated) to activity-based regulations.
Here is my tentative compilation of blockchain regulatory issues classified according to the types of activities. It is not intended to be exhaustive. The lending and deposit-taking of cryptocurrencies, for example, are not included. An ICO (Initial Coin Offering) will involve both (1) Exchange with other tokens or fiat currencies and (5) Crowdfunding. (7) The trading of CBDC (Central Bank Digital Currencies) is not yet a reality but may come about at some point in the future.
Wednesday, 14 March 2018
Blockchain and Online Dispute Resolution
The second of my papers delivered at the APEC workshop is also available here at the APEC website. It is "Blockchain and Online Dispute Resolution" (2018/SOM1/EC/WKSP2/017).
The paper considers the possible impact of the blockchain technology on the ODR rule making. It foresees that the world of online market will gradually flatten. Thus, the domination of big and powerful enterprises in the current hub-and-spoke model may be eroded with the emergence of the sharing economy model where MSMEs (micro, small and medium enterprises) will have a growing profile. This trend may be accelerated in the future, with the blockchain technology facilitating the P2P model where consumer-to-consumer transactions will also increase.
In this process, the characterization of consumers as the weaker parties will become less real or relevant, rendering consumer protection less of legislative priority in the ODR rule-making. This will be particularly significant in view of the great difficulties experienced in the earlier work of UNCITRAL on ODR which had been caused by legislative preoccupation with consumer protection.
The paper considers the possible impact of the blockchain technology on the ODR rule making. It foresees that the world of online market will gradually flatten. Thus, the domination of big and powerful enterprises in the current hub-and-spoke model may be eroded with the emergence of the sharing economy model where MSMEs (micro, small and medium enterprises) will have a growing profile. This trend may be accelerated in the future, with the blockchain technology facilitating the P2P model where consumer-to-consumer transactions will also increase.
In this process, the characterization of consumers as the weaker parties will become less real or relevant, rendering consumer protection less of legislative priority in the ODR rule-making. This will be particularly significant in view of the great difficulties experienced in the earlier work of UNCITRAL on ODR which had been caused by legislative preoccupation with consumer protection.
Blockchain and Smart Contract for Contract Management (Dispute Prevention, Generation and Resolution)
A workshop on developing an ODR framework was organized by the APEC (Asia-Pacific Economic Cooperation) Economic Committee on 3-4 March 2018 at Port Moresby (Papua New Guinea). I was invited by the Department of Justice of Hong Kong to deliver two papers.
The first paper "Blockchain and Smart Contract for Contract Management (Dispute Prevention, Generation and Resolution)" (2018/SOM1/EC/WKSP2/005) is now published here on the APEC website.
The title is mouthful as it lists all the elements flagged by the organizers. After comparing and contrasting smart contracts with computer codes running in a central server, the paper notes that "smart contracts" are not contracts in the legal sense and considers their implications for contract management and dispute prevention. It alerts that the features of smart contracts are prone to generate disputes which often involve novel legal issues. The paper concludes with a brief comment on the potential use of smart contracts in dispute resolution.
The first paper "Blockchain and Smart Contract for Contract Management (Dispute Prevention, Generation and Resolution)" (2018/SOM1/EC/WKSP2/005) is now published here on the APEC website.
The title is mouthful as it lists all the elements flagged by the organizers. After comparing and contrasting smart contracts with computer codes running in a central server, the paper notes that "smart contracts" are not contracts in the legal sense and considers their implications for contract management and dispute prevention. It alerts that the features of smart contracts are prone to generate disputes which often involve novel legal issues. The paper concludes with a brief comment on the potential use of smart contracts in dispute resolution.
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