Archive by Author | Juha

Transatlantic Antitrust and IPR Developments, Newsletter Issue No. 5/2018 (November 2, 2018)

Contributors:

Gabriel M. Lentner, Jonathan Cardenas,
Kletia Noti, Marie-Andrée Weiss

Editor-in-chief: Juha Vesala

 

Contents     

Intellectual property

United States

A Study in Trademarked Characters

There is Such Thing as Bad (Right of) Publicity

What’s New in the US-Mexico-Canada Agreement (USMCA)

Other developments

United States

Olivia de Havilland Asks Supreme Court to Review Docudrama Right of Publicity Case

European Union

The UK House of Commons Treasury Committee Report on Crypto Assets

The European Commission Wants to Reform the World Trade Organization

Injunctions and Article 15(I) of the E-Commerce Directive: The Pending Glawischnig-Piesczek v. Facebook Ireland Limited Preliminary Ruling

Read More…

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A Study in Trademarked Characters

By Marie-Andrée Weiss

The characters created by Disney, Marvel, and LucasFilms are valuable intellectual property and are protected both by copyright and by trademark. However, a recently decided case in the Southern District of New York (SDNY), Disney Inc. v. Sarelli, 322 F.Supp.3d 413 (2018), demonstrates that preventing the unauthorized use of such characters may not be as easy as expected.

In this case, Plaintiffs are Disney Enterprises, Marvel Characters and LucasFilm, all of which own copyrights and trademarks in many of the most famous characters in the world, such as Mickey Mouse, Hulk, and Chewbacca. These characters were first featured in movies like Frozen, The Avengers or Star Wars, and are now licensed or featured in derivative products such as comic books, video games, or theme parks. Their exploitation is highly lucrative.

When visiting Plaintiffs’ theme parks, one has a chance to meet the characters “in person.” This experience is also offered by Characters for Hire, a New York company offering, as the name implies, character hiring services. The company’s principal owner is Nick Sarelli (Defendant). Characters for Hire offers a service wherein actors dressed in costumes entertain guests during birthday parties or corporate events. For example, actors have allegedly dressed as Mickey, Elsa and Anna from Frozen, Captain America and Hulk from The Avengers, and Luke Skywalker and Darth Vader from Star Wars.

The contracts Defendants provided to their clients contained disclaimer language, stating, for example, that Defendants do not use trademarked and licensed characters. The contracts also warned clients that the costumes may differ from those seen in movies “for copyright reasons,” adding that “[a]ny resemblance to nationally known copyright character is strictly coincidental.”

These disclaimers did not appease Plaintiffs, who sent several cease and desist letters to Defendants before filing a federal copyright and trademark infringement suit and a New York trademark dilution suit.

While Judge Daniels from the SDNY granted Defendants’ motion for summary judgment and dismissed Plaintiffs’ claim for trademark infringement on August 9, 2018, he denied the motion to dismiss the copyright infringement claim and the trademark dilution claim.

 

The descriptive fair use defense failed

Plaintiffs claimed that the use of their trademarked characters to advertise and promote Defendants’ business, along with their portrayal by costumed actors, was likely to confuse consumers as to the origin of the services.

Defendants argued that their use of Plaintiffs’ characters was descriptive and nominative fair use, and that there was no likelyhood of confusion.

Descriptive fair use is an affirmative defense to a trademark infringement suit, as Section 33(b)(4) of the Trademark Act allows “use… of a term or device which is descriptive of and used fairly and in good faith [but] only to describe the goods or services of such party, or their geographic origin.” In other words, a defendant can use plaintiffs’ trademarks in a descriptive sense, or to describe an aspect of his own good or service.

For such a defense to succeed in the Second Circuit, a defendant must prove that the use was made (1) other than as a mark, (2) in a descriptive sense, and (3) in good faith (Kelly-Brown v. Winfrey at 308). This defense failed in the present case, as Defendants had not made a descriptive use of Plaintiffs’ marks. Instead, Judge Daniels found that their ads “were specifically designed to evoke [Plaintiff’s marks] in consumers’ minds…”

 

The nominative fair use defense also failed

Defendants also claimed that they used Plaintiffs’ marks to describe their own products. Such nominative fair use is a defense to a trademark infringement suit if such use “does not imply a false affiliation or endorsement by the plaintiff of the defendant” (Tiffany v. eBay at 102-103). But this nominative fair use defense also failed, as Defendants used Plaintiffs’ marks to identify their own service, which is hiring out characters for parties, rather than Plaintiffs’ trademarked characters.

 

Defendants’ use of characters was not trademark infringement

Judge Daniels used the eight-factor Polaroid test used by the Second Circuit in trademark infringement cases to determine whether Defendants’ use of Plaintiffs’ marks were likely to confuse consumers.

While Plaintiffs’ marks are undoubtedly strong (first factor), the similarity of the marks (second factor), weighed only slightly in Plaintiffs’ favor because Defendants used different names for their characters than Plaintiffs’ trademarked character names, e.g., “Big Green Guy,” “Indian Princess,” and “The Dark Lord” instead of Hulk, Pocahontas and Darth Vader.

The third and fourth Polaroid factors, the proximity of the goods and services, and the possibility that the senior user will enter the market of the junior user, were found to weigh in Defendants’ favor. There was no evidence that Plaintiff has plans to expand into the private entertainment service industry.

The fifth Polaroid factor, evidence of actual confusion, also weighed in Defendants’ favor, as there was no evidence that Defendants’ customers used the names of Plaintiffs’ trademarked characters when referring to Defendants’ services in online reviews or otherwise. Plaintiffs could not provide a survey proving customers’ confusion either.

Judge Daniels found the sixth factor, Defendants’ intent and evidence of bad faith, to also be in Defendants’ favor, since Defendants had put customers on notice that their services were not sponsored by or affiliated with Plaintiffs by using altered versions of Plaintiffs’ characters’ names and by removing Plaintiffs’ characters’ names in their online reviews.

The seventh Polaroid factor, the quality of Defendants’ products, was also in Defendants’ favor, as Defendants’ services, being of a lesser quality than Plaintiffs’, makes it likely that consumers will not be confused as to the source of the services.

The eighth Polaroid factor, consumer sophistication, also was in favor of Defendants, as Plaintiffs did not prove the sophistication level of Defendants’ relevant consumers.

Balancing these eight factors, the SDNY found no likelihood of consumer confusion and denied Plaintiffs’ motion for summary judgment on their trademark infringement claim.

 

Trademark dilution

Plaintiffs chose to claim trademark dilution under New York trademark dilution law, Section 360-1 of New York Business Law, and not under the Federal Trademark Dilution Act. This choice may have been made because the New York law does not require a mark to be famous to be protected, and a plaintiff only needs to prove the mark’s distinctiveness or secondary meaning.

Judge Daniels found that there was a genuine issue of fact as to whether Defendants’ use of Plaintiffs’ marks is likely to dilute Plaintiffs’ marks by tarnishment. A court will have to determine if Defendants provide services of poor quality.

 

Copyright

Plaintiffs argued that Defendants had “copied and used the images, likenesses, personas, and names of Plaintiffs’ characters…to promote and advertise its services online.” Defendants argued in response that the characters in which Plaintiffs own copyrights are based on prior works that are part of the public domain.

Both parties will have more chances to pursue their arguments as Judge Daniels denied the motion for summary judgment on copyright infringement. He found that Plaintiffs had presented as evidence screenshots from Defendants’ website and videos allegedly published by Defendants which had not been properly authenticated. More specifically, they had not been authenticated by someone “with personal knowledge of reliability of the archive service from which the screenshots were retrieved,” citing Specht v. Google, a 2014 Seventh Circuit case.

It is likely that the parties will settle out of court.

There is Such Thing as Bad (Right of) Publicity

By Marie-Andrée Weiss

Last June, the New York legislature failed, once again, to amend the state’s right of publicity law. A similar bill, Assembly Bill A08155, had the same fate last year. New York Assembly Bill 8155-B had passed the assembly on June 18, 2018, but the Senate did not bring the bill to a vote before the legislature adjourned. This is fortunate, as the bill had several flaws.

 

The current New York right of publicity law

New York statutory right of privacy, Civil Rights Laws §§ 50 and 51, is a narrowly drafted law. The New York Court of Appeals recently described the legislative intent at passing this law as “slender” (Lohan v. Take-Two Interactive Software, Inc.). Indeed, the law does not provide an extensive right of publicity, but merely makes it a misdemeanor to use a living person’s likeness, that is, her name, portrait or picture, “for advertising or trade purposes” without prior written consent. New York does not recognize any other privacy rights, not even at common law.

 

Identity as personal property

The bill clearly differentiated the “right of privacy” from the “right of publicity.” During a person’s lifetime, a person would have had a right to privacy and a right to publicity. Both rights would have prevented the unauthorized use of likenesses and names, but only the right of publicity would have provided the right to sell one’s persona.

The “right of privacy” was defined as a “personal right, which protects against the unauthorized use of a living individual’s name, portrait or picture, voice, or signature for advertising purposes or purposes of trade without written consent.” This is essentially the right that is currently protected in New York. The bill would have also protected a person’s signature, which is not currently protected. Moreover, under the bill, this right of privacy would have expired upon death, just as it does now.

The bill would have also created a “right of publicity,” defined as “an independent property right, derived from and independent of the right of privacy, which protects the unauthorized use of a living or deceased individual’s name, portrait or picture, voice, or signature for advertising purposes or purposes of trade without written consent.”

The bill would have made an individual’s persona his or her personal property, “freely transferable or descendible, in whole or in part by contract or by means of any trust or testamentary instrument.” The bill would, therefore, have made it possible to transfer one’s persona, by selling it or licensing it, for a limited or unlimited time, and these contracts would have been able to survive death.

 

The dangers of making identity a transferable personal property

SAG-AFTRA, a performers’ union, supported the bill. Its New York President urged its New York members to let their representatives know that they were in favor of passing the bill. However, the bill, as written, could have placed actors in danger of losing the right to use and profit financially from their personality.

The Fantine character, created by Victor Hugo in Les Misérables, sold her hair so she could send money to her daughter Cosette. One can imagine an actress, who once played Fantine in a Les Mis production, but who has since fallen on hard times, selling her entire persona in order to make ends meet. Hair can grow again, but under the bill, a persona could have been sold off for a long time, even forever. One could even imagine a persona becoming a commodity under the new law, with producers buying personas straight out of a ‘central-casting’ database. Representative Morelle noted during the debate that “[i]f someone looks like another person, that’s not covered under this. You could go find someone who looks like Robert De Niro, or you could find someone that looks like another actor.”

The bill would have thankfully forbidden parents or guardians from assigning the right of publicity of a minor and would have rendered such assignments unenforceable. Under this bill. Fantine could have sold her own persona, but not Cosette’s.

 

A descendible right of publicity

Unlike other states, such as California, New York does not have a post-mortem right of publicity. The bill would have provided such a right for forty years after a person’s death, whether she was famous or not. At the expiration of the forty-year period, the image of an individual would have been freely usable.

This right would have been descendible, either by testament or by intestate succession. Either way, the right would have been enforced by a person or persons possessing at least a fifty-one percent interest of the individual’s right of publicity.

Persons claiming to be successors in the right of publicity of a deceased individual, or licensees of such rights, would have had to register their claim with the New York Secretary of State and pay a $100 fee. Thereafter, their claim would have been posted on a public web site specifically designed for that purpose. Parties interested in licensing or buying a particular right of publicity could have used this registry to find out who owns a particular right. Failure of a licensee or successor to register a persona would have been a defense for unauthorized use of the deceased’s persona. The sponsor of the bill, Representative Joseph Morelle, specified during the debate that the law would apply to anyone seeking damages in New York, provided that the interest had been registered in the New York registry.

The Electronic Frontier Foundation argued in a memorandum sent to the New York legislature that the law would pressure heirs to benefit commercially from the image of their deceased relatives, noting that in “a large estate, an inheritable and transferable right of publicity may add to the tax burden and thus lead heirs with no choice but to pursue advertising deals or some other commercial venture.” Indeed, deceased artists such as Glenn Gould or Franck Zappa are back on the road performing as holograms.

 

Fake News, Deepfakes and the right to publicity

The bill addressed the issue of “digital replica,” which it defined as a “computer-generated or electronic reproduction” of the likeness or voice of a person, whether alive or dead. Representative Morelle explained that the bill aimed at codifying the recent Lohan v. Take-Two Interactive Software decision, where the court found that New York right of privacy law, which protects unauthorized use of a “portrait,” encompasses the “graphical representation of a person in a video game or like media.”

Use of such digital replicas would have been forbidden, without prior authorization, in expressive works such as a live performance, a dramatic work, or a musical performance “in a manner that is intended to create, and that does create, the clear impression that the individual represented by the digital replica is performing, the activity for which he or she is known.” Athletes’ digital replicas could not have been used in audiovisual works either, if doing so created “the clear impression that the athlete represented by the digital replica is engaging in an athletic activity for which he or she is known.” This was probably aimed at protecting athletes against the unauthorized use of their likenesses in video games.

The dystopian movie The Congress featured actress Robyn Wright selling the right to her digital image to a studio, under an agreement which forbade her to ever act again. Even more sinister is the prospect of selling one’s digital image for making pornographic movies. Indeed, Artificial Intelligence (AI) technology allows creation of “deepfakes” video where a person is depicted as performing sexual acts. Such technology can be used to seek revenge (so-called revenge porn) or simply to create porn movies featuring celebrities. The bill specifically addressed the issue of unauthorized use of digital replicas in a pornographic work and would have forbidden the use of digital replicas in a manner intended to create, or which did create “the impression that the individual represented by the digital replica is performing [in such pornographic work]”.

Representative Morelle also mentioned during the debate that digital replicas can be used to create fake news, for instance, by making political figures look and sound as if they are saying something they did not actually say, which brings us to the First Amendment issues this bill raised.

 

First Amendment Issues

New York courts found that the use of a person’s likeness with respect to “newsworthy events or matters of public interest” is non-commercial and therefore not actionable under New York’s right of publicity law (Stephano v. News Group Publs.).

Use of digital replicas would have been authorized for parody, satire, commentary or criticism purposes, or “in a work of political, public interest, or newsworthy value,” or if the use was de minimis or incidental.

The bill would have explicitly provided a First Amendment defense to the use of a persona without prior consent, including use in a book, play or movie. This is in line with the recent California case, Olivia de Havilland v. Fox Networks, which had pitted the centenarian actress against the producer of Feud: Bette and Joan, an eight-part television show about the Joan Crawford/Bette Davis rivalry. Catherine Zeta-Jones portrayed Olivia de Havilland, and was shown in the movie giving an interview wherein she referred to her sister Joan Fontaine as a ‘bitch’, among a few more unsavory comments. Olivia de Havilland sued for infringement of her California right to publicity but lost because the use of her name and likeness in the movie was protected by the First Amendment. The case shows how public figures cannot always rely on their right of publicity to censor speech about themselves which they deem unsavory.

It has been reported that Olivia de Havilland plans to ask the Supreme Court to review the case, and the New York legislature is likely to introduce a new version of its right of publicity bill in the coming months. Right of publicity is developing, warts, holograms, and all.

What’s New in the US-Mexico-Canada Agreement (USMCA)

As readers know, NAFTA has been turned into the United States – Mexico – Canada Agreement (USMCA). Along with changes to minimize barriers in the automobile and dairy sectors, intellectual property rights, data protection, and dispute settlement have undergone considerable alterations. These changes are addressed here.

 

IP Protection Extended

As for intellectual property rights, the negotiations have resulted in enhanced protections, an outcome mainly desired by the US (and with considerable similarities with the 2015 TPP text).

In regard to copyrights, Art.20.H.7 of the USMCA stipulates that, following the author’s death, his or her intellectual property rights shall be protected for 70 years onwards (thereby extending protection from the 50-year standard, by which Canada currently abides). In cases where no person’s life is used as a basis for the copyright term, the minimum is now set to 75 years from the date of the first authorized publication. In NAFTA, the minimum was 50 years.

Biologics are a field which NAFTA did not specifically regulate. Under the USMCA Art.20.F.14, however, patent protection for new pharmaceutical products that are (or contain) biologics will last 10 years from the date of first marketing approval of that product in the Party concerned. Note that biologics protection in Canada is currently only 8 years. It is also important to highlight that the USMCA provides for a patent-term restoration system, enacted after request, in cases where the applicant’s patent issuance has been ‘unreasonably’ delayed (Art.20.F.9).

 

IP Enforcement

Of utmost importance are the advanced enforcement provisions of IP rights protection. Under NAFTA, the competent authorities could act only after the filing of an application by the right holder (Art.1718). The USMCA provides for the ex officio authority of border officials to initiate border measures against suspected counterfeit trademark goods or pirated copyright goods which are imported, destined for export, in transit, or entering/exiting a free trade zone or a bonded warehouse; this is intended to combat the phenomenon of weak counterfeiting (Art.20.J.6). Further, the USMCA provides for the establishment of a new IP Committee, with the task of holding consultations on several cooperation issues (Art.20.B.3).

 

Digital Trade Chapter

When the original NAFTA came into force in 1994, digital trade was not considered in the agreement. USMCA, however, dedicates a whole chapter to it (Chapter 19). Two key points in Chapter 19 should be emphasized. First, the rules on data localization restrict policies that require companies to store personal information within the local jurisdiction, which seems to conflict with what is provided for in the relevant EU regulations. The cross-border transfer, storage and processing of data is facilitated under the USMCA through, inter alia, the prohibition of custom duties on the transfer of digital products and the requirement that Parties do not (unnecessarily) restrict the cross-border transfer of personal information.  Second, Art.20.J.11 introduces a safe-harbor provision for Internet Service Providers by requiring that parties limit the Providers’ liability for monetary relief in instances of infringements where they merely maintain, transmit, or store unauthorized information, but do not control, initiate or direct the infringement.

 

Limitation of Investor-State Dispute Settlement

Reformation of the dispute settlement mechanism is another field of practical and legal interest. Chapter 11 of NAFTA provided for investor-state dispute settlement (ISDS) for protected investments. The foreign investor had recourse to an arbitral tribunal to challenge host State measures. Canada has now entirely withdrawn from the ISDS system. Thus, investor-state disputes are only permitted between the US and Mexico, and only under certain conditions. First, they are only available for alleged violations of the standards of national treatment and ‘most-favored nation’, as well as direct expropriation disputes. Furthermore, ISDS is only available after local remedies have been exhausted or after a time lapse of 30 months. As far as minimum standards of treatment (fair and equitable treatment) and indirect expropriation are concerned, the investors can only pursue a claim before domestic courts.

Notably, specific categories of US investors are permitted to initiate proceedings relating to oil, gas, transportation, infrastructure, and power generation concession contracts concluded between them and the Mexican government (USMCA Annex 14-E). Yet, the state-to-state dispute settlement mechanism of NAFTA’s Chapter 19 has not undergone modification and remains in place.

 

Conclusion

The parties have chosen to maintain many of the original NAFTA principles, such as that bilateral and trilateral elements can coexist. The USMCA agreement, therefore, represents a compromise, bringing changes in some areas while leaving others untouched.

Olivia de Havilland Asks Supreme Court to Review Docudrama Right of Publicity Case

By Marie-Andrée Weiss

Actress Olivia de Havilland, DBE, is petitioning the Supreme Court of the United States for writ of certiorari for the following question:

“Are reckless or knowing false statements about a living public figure, published in docudrama format, entitled to absolute First Amendment protection from claims based on the victim’s statutory and common law causes of action for defamation and right of publicity, so as to justify dismissal at the pleading stage?”

It all started with the television ‘docudrama’ series Feud: Bette and Joan, about the Bette Davis and Joan Crawford rivalry. In the docudrama, Catherine Zeta-Jones portrayed Olivia de Havilland calling her sister Joan Fontaine a ‘bitch’, implying that Frank Sinatra is an alcoholic, and generally enjoying good juicy gossip, even at the expense of her close friend Bette Davis.

This did not sit well with Miss de Havilland, who prides herself on having achieved success “without sacrificing her strong moral and personal commitment to truth… and plain old fashioned good manners.” She found her portrayal in Feud to be  false and damaging to her reputation, and filed a right of publicity and false light invasion of privacy suit against the producers of the show in June 2017.

Defendants filed a motion to strike the complaint under the California Strategic Lawsuits Against Public Participation (anti-SLAPP) statute, which provides defendants the right to dismiss cases which chill expression because Plaintiff engages in a costly and time-consuming litigation.

The Los Angeles Superior Court denied the motion, finding that Feud was not “transformative” under the Comedy III Productions ‘transformative use’ test and thus not protected by the First Amendment. In Comedy III, the California Supreme Court had found that an unauthorized use of likeness is protected by the First Amendment if it is transformative.

Defendants appealed. The California Court of Appeal reversed on March 26, 2018, finding that the way Plaintiff had been portrayed in Feud was not “highly offensive to a reasonable person” and that the First Amendment protected the portrayal of Plaintiff without her permission. Plaintiff then petitioned the California Supreme Court to review the case. The court declined to do so on July 11, 2018, and Miss de Havilland is now petitioning the Supreme Court for a writ of certiorari.

Is docudrama a knowing or recklessly false publication?

The scope of the question Petitioner is asking the Supreme Court is rather narrow and focuses of the issues of so-called docudramas, which mixes real life elements and dramatization. She argues that the court should review the case as it is “the right vehicle for [the court] to… clarify whether the First Amendment creates a special immunity for knowingly false statements published in a docudrama at a time when this genre is at an all-time high point” (emphasis my own).

Petitioner also argues, somewhat more broadly, that knowing or recklessly false statements in any form are not protected by the First Amendment and that “false factual statements possess no intrinsic First Amendment value,” citing United States v. Alvarez.

False statements are not generally protected by the First Amendment. A docudrama is a fiction and fiction is, by essence, false. But concluding that fiction, because it is false, is not protected by the First Amendment would be a sophism.

The California right of publicity statute has an exception for matters of public interest if the use of the likeness of an individual has been made “in connection with any news, public affairs, or sports broadcast or account, or any political campaign.” Miss de Havilland argues that this public interest exception does not protect knowing or reckless publication, and that if a fiction about a real person is knowing and recklessly false, the person thus portrayed should have the right to sue for defamation and unauthorized use of her likeness without being prevented to do so by the First Amendment.

It would be surprising if the Supreme Court accepts review of the case because the issue at stake – whether creators have the right to portray real persons in works of fiction without their permission – is well settled. The decision of the Los Angeles Superior Court appears to be only a fluke, and was reversed by the California Court of Appeal, which held that a person portrayed in a book, play, film or television show does not have the right to control “the creator’s portrayal of actual people.”

This dismissal of Miss de Havilland’s claims was consistent with California case law. The Ninth Circuit held in the 2006 Sarver v. Chartier case that the right of publicity suit filed by an Army Sergeant allegedly portrayed in the Hurt Locker movie had been properly barred by the California anti-SLAPP statute. The film was based on an article published in Playboy magazine about Plaintiff’s experience while he worked as an explosive technician in Iraq.

However, it can be argued that the Sarver case actually supports Miss de Havilland’s argument. In Sarver, the Ninth Circuit did not use the Comedy III transformative test to reach the conclusion that the movie did not violate Plaintiff’s right of publicity because it is transformative enough. Instead, it extensively quoted the only Supreme Court right of publicity decision, Zacchini v. Scripps-Howard Broadcasting, where the Supreme Court concluded that the Ohio right of publicity statute could prevent broadcasting the entire performance of a “human cannonball” without violating the First Amendment, because petitioner had made significant economic investments in energy, talent and expense to prepare for his act.

The Ninth Circuit noted in Sarver that it interprets Zacchini as upholding a right of publicity “where the defendant appropriates the economic value that the plaintiff has built in an identity or performance” without considering whether defendant’s use is transformative or not. This interpretation may lead a case such as this one to be decided in favor of the plaintiff, especially if one considers that the practice of securing a ‘life rights agreement’ before portraying a particular person in a movie or television show is prevalent in the business and is thus another way to profit from the economic value of one’s identity.

The UK House of Commons Treasury Committee Report on Crypto Assets

By Jonathan Cardenas[1]

On September 19, 2018, the UK House of Commons Treasury Committee (the “Committee”) published a Report on Crypto-assets (the “Report”), which provides regulatory policy recommendations for the UK Government, the UK Financial Conduct Authority (the “FCA”) and the Bank of England.[2]   The Report forms part of the Committee’s Digital Currencies Inquiry, which was launched in February 2018 to examine the potential impact of distributed ledger-based digital currencies on the UK financial system and to prepare a balanced regulatory response from the UK Government.[3]  This article briefly summarizes the Committee’s UK regulatory policy recommendations.

 

  1. Crypto Asset Risk

The Committee’s regulatory policy recommendations are structured around a variety of risks that crypto assets pose to crypto asset investors.  These risks include: high price volatility; loss of investment due to fraud and/or third-party hacking of crypto asset exchanges; loss of access to crypto asset exchange accounts and/or digital wallets due to unrecoverable lost passwords; price manipulation due to poor market liquidity and relatively low trading volumes; potential facilitation of money laundering and terrorist financing; and, macro risk to UK financial stability.  Mindful of these risks, the Committee notes that crypto assets presently fall outside the scope of FCA regulation merely because the “transferring, buying and selling of crypto assets, including the commercial operation of crypto asset exchanges”[4] do not meet legal definitional criteria to be considered as either a “specified investment” under the Financial Services and Markets Act 2000 (Regulated Activities) Order (the “Regulated Activities Order”), or as “funds” or “electronic money” under applicable payment services and electronic money regulation, as referenced in expert witness reports provided to the Committee.[5]

 

  1. Initial Coin Offerings

Consumer fraud in the context of initial coin offerings (“ICOs”) is a topic of special concern to the Committee.  The Committee recognizes that there is currently “little the FCA can do to protect individuals”[6] from fraudulent ICOs as a result of a regulatory loophole that permits ICOs to escape FCA jurisdiction.  Since most ICOs do not directly promise financial returns, but rather, offer future access to a service or utility, they do not fall squarely within UK law definitions of “financial instrument,”[7] as referenced in expert witness reports provided to the Committee, and therefore are not FCA regulated.

The Committee concurs with the view of U.S. Securities and Exchange Commission Chairman Jay Clayton that ICOs should not escape the ambit of securities regulation merely because they change the form, and not the actual substance, of a securities offering.[8]  The Committee also concurs with the view expressed in an FCA warning that consumers should be prepared to lose their entire investment in early stage ICO projects due to the FCA’s lack of jurisdiction and consequent inability to protect consumers.[9]  As a result, the Committee recommends that the Regulated Activities Order be updated, as a matter of urgency, in order to bring ICOs within the scope of FCA jurisdiction.

 

  1. Crypto Asset Exchanges

The facilitation of money laundering and terrorist financing through crypto asset exchanges is another area of major concern addressed by the Committee.  Crypto asset exchanges are not currently required to comply with anti-money laundering (“AML”) rules under UK law because their activities are not specifically captured by the language of UK AML regulation, including, most notably, the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017.[10]  Although current UK AML regulation does not target crypto asset exchange activity, crypto asset exchanges do fall within the scope of the European Union’s 5th Anti-Money Laundering Directive (the “5th AML Directive”).[11]  As a consequence, the Committee recommends that the UK Government either (1) transpose the 5th AML Directive into UK law prior to the UK’s planned exit from the EU, or (2) replicate relevant provisions of the 5th AML Directive in UK law as quickly as possible.

 

  1. Regulatory Implementation

The Committee proposes two ways of introducing crypto asset regulation in the UK: (1) by amendment of existing financial services regulation or, (2) by adoption of new regulation tailored specifically to crypto assets.

Amending the existing financial services regulatory framework would involve classifying crypto asset activity as a regulated activity within the Regulated Activities Order.  Doing so would enable the FCA to regulate crypto asset activities by, for example, mandating that licenses be obtained in order to carry out specified crypto activities in the UK.  This approach has previously been used in the context of peer-to-peer lending,[12] and is regarded as the fastest way of providing the FCA with the powers needed to regulate crypto asset activities and protect UK consumers.

Adopting a new regulatory framework separate from pre-existing financial services rules would allow for a more flexible and tailored approach to crypto asset regulation, but would also require substantially more time to formulate and finalize.

Given the rapid growth of crypto asset markets and the expanding set of risks faced by UK consumers, the Committee recommends that the UK Government regulate crypto asset activities by expanding the scope of the Regulated Activities Order, rather than by adopting a separate body of rules.  The Committee also recommends that the UK Government examine the exact type of crypto asset “activity” that would be included in an amended Regulated Activities Order, as well as the ramifications of doing so.

The Committee notes that although the global regulatory response to crypto assets is in early stages, the UK is in a position to learn from the experience of other jurisdictions given the fact that the UK has not yet introduced any specific type of crypto asset regulation.  As a result, the Committee encourages UK regulators to engage with their international counterparts in order to ensure that best practices are applied in the UK.

[1] Disclaimer: The views and opinions expressed in this article are those of the author alone.  The material in this article has been prepared for informational purposes only and is not intended to serve as legal advice.

[2] UK House of Commons Treasury Committee, Crypto-assets, Twenty-Second Report of Session 2017-19, 19 September 2018. Available at: https://publications.parliament.uk/pa/cm201719/cmselect/cmtreasy/910/910.pdf.

[3] UK House of Commons Treasury Committee, Digital Currencies inquiry: Scope of the inquiry, 2017.  Available at: https://www.parliament.uk/business/committees/committees-a-z/commons-select/treasury-committee/inquiries1/parliament-2017/digital-currencies-17-19/.

[4] UK House of Commons Treasury Committee, Evidence – Financial Conduct Authority (DGC0028): Financial Conduct Authority’s written submission on digital currencies, April 2018.  Available at: http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/treasury-committee/digital-currencies/written/81677.pdf.

[5] UK House of Commons Treasury Committee, Evidence – Financial Conduct Authority (DGC0028): Financial Conduct Authority’s written submission on digital currencies, April 2018.

[6] UK House of Commons Treasury Committee, Crypto-assets, 19 September 2018, at para 87.

[7] UK House of Commons Treasury Committee, Oral evidence: Digital Currencies, Statement of David Geale, Q 193, HC 910, 4 July 2018. Available at: http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/treasury-committee/digital-currencies/oral/86572.html.

[8] U.S. Securities and Exchange Commission, Statement on Cryptocurrencies and Initial Coin Offerings, December 11, 2017. Available at: https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11.

[9] Financial Conduct Authority, Consumer warning about the risks of Initial Coin Offerings (‘ICOs’), 9 December 2017. Available at: https://www.fca.org.uk/news/statements/initial-coin-offerings.

[10] The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (S.I. 2017/692), 26 June 2017. Available at: http://www.legislation.gov.uk/uksi/2017/692/made.

[11] Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU, OJ L 156, 19.6.2018, p. 43–74. Available at: https://eur-lex.europa.eu/legal-content/en/TXT/?uri=CELEX%3A32018L0843.

[12] See Financial Conduct Authority, The FCA’s regulatory approach to crowdfunding (and similar activities), Consultation Paper 13/13, October 2013. Available at: https://www.fca.org.uk/publication/consultation/cp13-13.pdf.

The European Commission Wants to Reform the World Trade Organization

By Gabriel M. Lentner and Filippo Faccin

On September 18, 2018, the EU Commission issued a concept paper on WTO reform. In this paper, the EU Commission recognizes that the rules-based multilateral trading system faces its deepest crisis since its inception. Against this background, the Commission seeks to move the debate toward a focus on the reform of the WTO.

The concept paper covers 3 issues:

  • Rulemaking and development
  • Regular work and transparency
  • Dispute settlement

 

Rulemaking and Development

The first proposals in this area concern industrial subsidies and state-owned enterprises (SOEs).

Recognizing the low level of compliance with the Agreement on Subsidies and Countervailing Measures (SCM Agreement) the EU proposes, inter alia, the creation of a general rebuttable presumption according to which if a subsidy is not notified or is counter-notified, it would be presumed to be a subsidy or even a subsidy causing serious prejudice.

As regards SOEs, a clarification of what constitutes a public body is proposed that seeks to broaden the existing definition, which, according to the EU Commission does not capture many relevant SOEs. In addition, rules concerning enhanced transparency about the level and degree of state control in SOEs and other market-distorting support are proposed.

Other proposals in this context are concerned with the expansion of the list of prohibited subsidies or the creation of a rebuttable presumption of serious prejudice. Non-insolvent companies without a credible restructuring plan or companies that use dual pricing will no longer have access to grants.

Establishing new rules to address barriers to services and investment, such as in the field of forced technology transfer are another priority.

The Commission also proposes to strengthen the procedural aspects of the WTO’s rulemaking activities. It argues that the EU should maintain support for multilateral negotiations and full outcomes in areas where this is possible, and should also explore the feasibility of amending the WTO agreement so as to create a new Annex IV.b. This annex would contain a set of plurilateral agreements that are applied on an MFN-basis and which could be amended through a simplified process.

Furthermore, the EU seeks to strengthen the role of the WTO secretariat in support of the various negotiation processes as well as the implementation and monitoring functions.

 

Regular Work and Transparency

The EU has consistently criticized the slow processes and the burdensome bureaucracy of the WTO, which paralyzes its regular work.

The solution that has been proposed is the development of rules that oblige members to provide substantive answers within specific deadlines and the increase of cross-committee coordination on issues related to market access.

The EU Commission concept paper defends the strengthening of the organization’s monitoring powers to check whether countries are implementing multilateral agreements and transparent trade policies. In particular, the EU Commission wants the WTO to implement:

  • More effective committee-level monitoring
  • Incentives for improving notification compliance
  • Sanctions for willful and repeated non-compliance
  • Counter-notifications
  • A strengthening of the Trade Policy Review Mechanism (TPRM).

 

Dispute Settlement

The Commission paper states that the dispute settlement system is “at grave danger, and swift action by members is needed to preserve it”.

A solution is necessary to end US blocking new appointments and to prevent the imminent stalemate of the appeal body.

The first stage of a general reform will be a comprehensive amendment of the provision of the Dispute Settlement Understanding (DSU) related to the functioning of the Appellate Body (AB).  This amendment would:

  • Narrow the 90-day limit to resolve a dispute
  • Increase the number of members of the appeal body from 7 to 9 (This would help to increase the efficiency of the appeal body, while improving the geographical balance)
  • Configure the membership of the appeal body to work full-time (currently, de jure, it is a part-time job)