"Fractional Ownership Investment May Also Be Securities... Arbitrary Judgment on NFT Security Status Not Allowed"

[Asia Economy Reporter Ji Yeon-jin] In the 'Fractional Investment Guidelines' prepared by financial authorities following the Musicow incident, which viewed the possibility of classification as securities as low,

an interpretation has emerged that 'ownership of tangible assets' can also be recognized as having securities characteristics. Since fractional Non-Fungible Tokens (F-NFTs) that divide ownership can also be classified as securities, it is pointed out that the legality of fractional investments should not be arbitrarily judged.

According to the Korea Capital Market Institute on the 6th, Research Fellow Kim Gap-rae recently stated in the published 'Significance and Follow-up Tasks of the Fractional Investment Guidelines' that "the securities determination criteria and fractional investment securities handling principles presented in the fractional investment guidelines increase business predictability for sound fractional investment operators and prevent large-scale damage caused by the transfer of regulatory risks from unsound operators to fractional investment investors, which is significant."

However, he pointed out that the part of the guideline stating "if ownership, etc., is directly divided or can be individually used, enjoyed, or disposed of, the possibility of being securities is relatively low" should be approached with caution. This means that when customers are granted real rights or quasi-real rights, the securities nature of the fractional investment product is relatively lower compared to when claim rights are granted, but it does not mean that the securities nature is denied.

According to the US Howey ruling, the origin of the concept of investment contract securities, investors had apparent ownership because they purchased orchard land. However, in that case, investors re-leased the real estate they invested in, and the expected profits largely depended on the efforts of the issuer, Howey, resulting in high information asymmetry and agency costs, so the related investment contract was recognized as a security.

Research Fellow Kim said, "In the same context, F-NFTs may also be classified as securities such as investment contract securities depending on the case," and added, "Hester Peirce, a commissioner of the US Securities and Exchange Commission (SEC), recently made remarks at a conference suggesting that F-NFTs could be defined as securities."

Earlier, the Financial Services Commission released the 'Guidelines for New Securities Businesses such as Fractional Investment' in April for fractional investment operators to refer to. According to this, fractional investment that acquires ownership of tangible assets by dividing it is subject to general commercial law, such as the Civil Act or Commercial Act. On the other hand, if one holds a claim right to the profits generated from the asset proportional to their shares, it is judged to have securities characteristics and is subject to regulations such as securities registration under the Capital Markets Act.

Research Fellow Kim also stated that since it is difficult for operators to judge the legality of fractional investment businesses solely based on the checklist presented in the guidelines, operators should not arbitrarily determine legality but should inquire about the legality of the fractional investment by submitting related materials to supervisory authorities.

It should also be noted that to apply for the financial regulatory sandbox for fractional investment securities, fractional investment operators are not allowed to both issue fractional investment securities and operate the trading platform for those securities.

However, if the trading platform operated by the fractional investment issuer is effectively the only distribution market for the investors, suspension of the platform's operation could cause significant damage to investors, so temporary operation may be allowed depending on the financial authorities' judgment. Even in this case, a sufficient conflict of interest prevention system and market operation system to protect investors must be established.

Research Fellow Kim said, "This guideline is based on the principle that fractional investment securities are distributed on trading platforms independent from the issuer," and added, "We can expect the emergence of dedicated trading platforms for fractional investment securities through financial regulatory sandboxes, etc."