Hong Kong Lawyer

MARCH 2018

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March 2018 • FINTECH 金 融 科 技 www.hk-lawyer.org 31 The law applying to the offering of securities and their marketing in Hong Kong, as set out in the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) and the Securities and Futures Ordinance ('SFO') (Cap. 571), is in general consistent with best international practices that prohibit accessing public capital unless registration or authorisation requirements are complied with or a relevant exemption applies. Tokens that are securities may also be subject to laws concerning regulated activities and the operation of exchanges and automated trading services. However, whether a specific token is a security will require careful consideration. The SFO's definition of "security" provides little assistance in relation to tokens that do not clearly fall into pre- established categories, such as shares or debentures. The definition of "collective investment scheme" ('CIS'), which is one form of security, is widely drafted and remains open to interpretation in its application. Hong Kong is absent of case law that provides useful guidance on either of these defined terms. The report of the UK's Financial Markets Law Committee (July 2008) has acknowledged that the definition of CIS in s. 253 of the UK Financial Services and Markets Act 2000, which the SFO's definition reflects, is very wide and subject to legal uncertainties. There have been a handful of cases in the UK that provide some limited assistance to understanding the CIS term, though less so regarding the particular characteristics of tokens. The scope of the term "security" has been more extensively explored in the U.S. and the ICO community has long been well aware of the relevance of the test established by the U.S. Supreme Court in SEC v. W.J. Howey Co. (328 U.S. 293 1946) ('Howey'). Howey established that an "investment contract", which is one type of security as defined by the Securities Act of 1933, means "a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party" (Howey, 2). Howey is of interest here for two reasons. First, because Howey has been applied to tokens by the U.S. SEC. First in the 21(a) Report to the Slock.it ICO and most recently (December 2017) to the "Munchee" ICO. Slock.it unsuccessfully sought to take its tokens outside of the securities legislation via a distributed autonomous organisation ('DAO') that tried to remove the concept of a third party's efforts. "Munchee" actively promoted that its tokens could be traded and investors could expect to profit from the increase in the value of the tokens as a result of the efforts of its promoters, ie a purchaser of the tokens could expect profits from the efforts of another. Both of these cases are relatively clear cut, and that may not always be the case. That began to change with the rapid growth of offerings in 2017 and following the "21(a) Report" issued by the U.S. Securities and Exchange Commission ('U.S. SEC') in July 2017. The 21(a) Report concluded that a token known as "Slock.it" was a security, although it had not been promoted as such. The U.S. Sec and the Hong Kong Securities and Futures Commission ('SFC')) have recently gone on the offensive to warn issuers and market professionals not to put form over substance when structuring tokens as a means of seeking to circumvent securities laws that serve to protect investors, and are accordingly applying greater scrutiny to ICOs. What is a "security"? In consequence of the foregoing, there has been a more profound examination of what are the features of a utility token that might render it to be regarded as a security.

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