The Financial System Council “Working Group on the Provision of Risk Money to New/Growth Companies” discussed, from the point of view of fostering the provision of risk money to new/growth companies, how regulations concerning intermediaries between new and growing companies and investors could encourage such companies to raise funds from investors over the internet (“investment crowdfunding”).
The report by this Working Group (“Report”), published on December 25, 2013, refers to the U.S. JOBS Act (Jumpstart Our Business Startups Act), and indicates that it would be desirable to ease the entry regulations of intermediaries as a special treatment for Type 1 and 2 Financial Instruments Business Operators, from the point of view that easing the regulations of entry of intermediaries encourages investment crowdfunding.
In response to this Report, the 2014 Draft Amendment Act to the Financial Instruments and Exchange Act and others (“Amendment Act”), which was submitted to the Diet (the 186th Session of the Diet) on March 14 this year, effectively eased regulations on Type 1 and 2 Financial Instruments Operators, who handle public offerings of securities by investment crowdfunding. On the other hand, the Amendment Act sets out, in order to protect investors, regulation of certain conduct by intermediaries of crowdfunding such as the obligation to provide information on the internet and the establishment of a business management system.
In this bulletin, we explain about the special treatments of Type 1 and 2 Financial Instruments Business which are intermediary businesses in investment crowdfunding operations.
If the Amendment Act is approved without any change after the Diet discussion, the provisions of the Amendment Act referred in this bulletin will come into force on the date designated by the government ordinance within one year from the promulgation of the Amendment Act.
- Intermediaries/Intermediate Business concerning Which Regulations Are Eased
The Amendment Act defines businesses subject to the regulation of financial instruments business via investment crowdfunding as “Electronic Subscription Business”. In detail, Electronic Subscription Business means to perform acts, as a business, listed in Item 9, Paragraph 8 Article 2 of the Financial Instruments and Exchange Act (“FIEA”) (handling Public Offerings, Secondary Distributions of Securities, handling Private Placements or offering to specific Securities investors) through an electronic data processing system or any other information technology provided by the cabinet office ordinance.”
Electronic Subscription Business has two categories based on the type of securities handled by intermediaries, one is stocks and the other is fund interests. Electronic Subscription Business through the issue of stock is defined as “Type 1 Handling of Electronic Small Amount Subscription Business” which stipulates (i) the Electronic Subscription Business, which is limited to the business to be done by public offering or private placement of securities listed in Item 9, Paragraph 1, Article 2 on the FIEA and to meet requirements by government ordinance that the subscription amount needs to be small, or (ii) to receive deposits from clients. The total issue amount of securities, as the government rules, is expected to be less than 100 million yen and the subscription amount to be under 500 thousand yen per person1.
On the other hand, Subscription Business by the issue of fund interests is defined as “Type 2 Handling of Electronic Small Amount Subscription Business” which stipulates the Electronic Subscription Business to be done by public offering or private placement of securities (the rights listed in Item 5 or 6, Paragraph 2, Article 2 on the FIEA, which are deemed securities under paragraph 2, Article 2, and those listed on item 3, Article 3 or not listed on Financial Instruments Exchanges and excluding those set out by the government ordinance) and to meet the requirements by the government ordinance that the subscription amount needs to be small. The total issue amount of securities, as the government rules, is expected to be less than 100 million yen and the subscription amount to be under 500 thousand yen per person2.
Type 2 Electronic Small Amount Subscription Business limits securities subject to public offering, etc. to either Items listed in 3, Article 3, or non-listed securities. Based on this, Type 2 Electronic Small Amount Subscription Business does not include public offerings of the securities targeted at businesses that engage in investment mainly in securities, and considers that such businesses are recognized as the regular Type 2 Financial Instruments Business.
Type 1 Electronic Small Amount Subscription Business includes receiving deposits from clients for Electronic Subscription Business as mentioned in the above provision, and it also includes receiving deposits for Type 2 Electronic Small Amount Subscription Business.
- Easing of Entry Regulation
Entry Regulation of intermediaries of fund raising over the internet has been eased as below.
(1) Type 1 Electronic Small Amount Subscription Business
When entering into (registering for) only Type 1 Electronic Small Amount Subscription Business within Type 1 Financial Instruments Business, restriction against second job and regulation of capital to risk ratio, required for the registration of ordinary Type 1 Financial Instruments Business, are not imposed, and the capital amount requirement will be lowered to 10 million yen from 50 million yen which is currently in principle for the ordinary Type 1 Financial Instruments Business (planned to be applied by the government ordinance)3.
In addition, After a registration of Type 1 Electronic Small Amount Subscription Business Operators (who have been registered under Article 29 of the FIEA or have changed their registration by an application with statement that they perform only Type 1 Electronic Small Amount Subscription Business within Type 1 Financial Instruments Business), they will not be imposed with restrictions against second job, the obligation to reserve Financial Instruments Business Liability Reserve, and regulation of capital to risk ratio.
(2) Type 2 Electronic Small Amount Subscription Business
When entering into (registering for) only Type 2 Electronic Small Amount Subscription Business within Type 2 Financial Instruments Business, the capital amount requirement will be lowered to 5 million yen from 10 million which is currently in principle for the ordinary Type 2 Financial Instruments Business (planned to be applied by the government ordinance)4.
- Provision of Conduct Regulation
In order to prevent fraudulent acts using online fund raising structures, this Report indicates that it would be appropriate to impose the obligation to perform due diligence on issuers, to establish a system for providing suitable information through the internet and to provide information about issuers and intermediaries through the internet for intermediaries (existing Financial Instruments Business Operators and special treatment operators mentioned at the above (1)5 ) who handle public offerings or private placements of unlisted shares or fund interests through internet. In addition, it would also be appropriate to set out penalty provisions where operators fail to provide such information.
In response to this Report, the Amendment Act added a new obligation to establish a business management system by Financial Instruments Business Operators, etc. Although the details of this obligation are scheduled to be decided by the Cabinet Office ordinance, it is expected that the obligations in relation to “due diligence on issuers and establishment of a system for providing proper information over the internet” mentioned in the Report will likely to be prescribed.
In addition, the Amendment Act provides that when Financial Instruments Business Operators handle Electronic Subscription Business for securities unlisted or listed in each Item of Article 3, those operators shall enable access to information over the internet, during the period of electronic subscription dealing, as ruled by the cabinet ordinance as the method to use the electronic processing system or the method to use other IT Technology. This is for the items defined by the Cabinet as effective in deciding upon the clients, among all written items on the documents which are to be provided prior to the execution of the contract. Regarding the penalty in case of violation of this conduct regulation, those operators who fail to enable access or place false information will be imposed with imprisonment for less than 6 months or a fine of less than 500 thousand yen, or both.
Furthermore, in a case where Type 1 Electronic Small Amount Subscription Business Operators perform as Type 1 Electronic Small Amount Subscription Business, the obligation to give notice in the signage at the business offices is not imposed. This exemption applies to Type 2 Electronic Small Amount Subscription Business Operators as well.
Moreover, since both Type 1 and Type 2 Electronic Small Amount Subscription Business Operators are registered under Article 29 of the FIEA, they are characterized as Financial Instruments Business Operators. Therefore, the general conduct regulations are applied to such operators as well as ordinary Type 1 and Type2 1 Financial Instruments Business Operators, such as duty of good faith, advertising regulation, the obligation of delivery of documents prior to the execution of the contract6 and on execution, and prohibition of Prohibited Acts.
- Self-Regulation by Self-Regulatory Organisation
At present, the self-regulation of Japan Securities Dealers Association (JSDA) prohibits handling public offerings or private placements of unlisted securities as a general rule. However, this Report points out that “a ban should be lifted so that existing Type 1 or special Type 1 Financial Instruments Business Operators can handle lower-priced securities over the internet”, so the self-regulation of JSDA will be eased following the enactment and enforcement of the Amendment Act.