[Opinion] Fractional Investment in Artworks and Others: Is It a Security or Not?

[Seong Hee-hwal, Professor at Inha University School of Law]

It is the golden age of fractional investment. If it can generate profit, any asset can be divided to enable fractional investment. Fractional investments in real estate and bonds, known as asset securitization, have been practiced for a long time, but recently, the scope has rapidly expanded to include art tech such as artworks and music copyrights, luxury watches and limited-edition sneakers, Korean beef (Hanwoo), and NFTs (digital asset certificates of authenticity). As the stock and cryptocurrency markets have calmed down, the MZ generation seeking high returns has also largely shifted their interest to fractional investments.

Although these all appear similar as investment instruments on the surface, their legal nature varies significantly?some qualify as securities, while others are merely ownership rights. If the legal nature is classified as securities, serious issues arise because the Capital Markets Act regulations apply to securities. When the Capital Markets Act applies, strict disclosure obligations prescribed by law must be fulfilled when issuing and selling the investment products, intermediaries must be licensed as investment brokers, and anyone involved in unfair trading faces severe civil and criminal liabilities. These are burdens that small businesses find difficult to bear.

The primary criterion for determining whether an investment product is a security under the Capital Markets Act is the concept of an investment contract security. The definition of investment contract securities under Korean Capital Markets Act is a codification of the ‘Howey Test’ established by the U.S. Supreme Court in a 1946 ruling. It is a contractual right to receive profits from a common enterprise primarily managed by others, where money or other assets are invested and profits or losses are shared. Since 1946, numerous investment instruments in the U.S. have been regulated based on the Howey Test, including land share sales combined with entrusted farming profit sharing, franchise contracts, pyramid schemes, resort condominium memberships, and even investments in silver foxes, cows, and earthworms?investment methods that would not ordinarily be considered securities but were ruled as such.

Key elements in judging investment contract securities are especially ‘investment profit,’ ‘efforts of others,’ and ‘enterprise.’ The purpose of ‘investment profit’ means it is not for consumption or commerce, ‘efforts of others’ means the fund raiser leads with minimal investor involvement, and ‘enterprise’ refers to profit-seeking activities with risk of failure. There is no academic consensus yet on the securities nature of recently emerged fractional investments, but I personally assess them based on these elements.

Fractional real estate investments are often called ‘digital real estate trust beneficiary token’ or ‘digital asset-backed securities’ (DABS). In these cases, investors receive not only co-ownership of the real estate but also rental income from the trust company’s management of the property, fulfilling all elements of investment contract securities, so they can be considered securities.

For artworks and music copyrights, if investors only hold co-ownership and enjoy price appreciation based on market valuation of the artworks or music, there is no ‘enterprise,’ making it difficult to classify as securities. However, if the platform company leading the fundraising distributes profits generated from activities such as artwork leasing to investors, the elements of ‘efforts of others’ and ‘enterprise’ exist, which may qualify as securities. For luxury watches or limited-edition sneakers, rental income is unlikely, and only investment profits from future value appreciation are expected, so there is only co-ownership without enterprise, making it difficult to consider them securities.

In the case of fractional Hanwoo investment, the cattle farming business uses funds collected from investors to purchase calves, raise them, and sell them for profit sharing. Since there is an ‘enterprise’ conducted through the efforts of the farming business, it can be considered a security. NFTs themselves are merely certificates of authenticity for digital assets and are not securities, but depending on how the underlying assets represented by NFTs are utilized, they may be simple ownership or securities with ‘enterprise’ characteristics, so a similar analysis to artworks can be applied.

As technological advances make economic activities more complex and specialized, it is hoped that fractional investments, as a new investment instrument, will protect investors while achieving economic innovation.

Seong Hee-hwal, Professor, Inha University School of Law