Existing Article 63 Exemption Operators will be subject to new obligations and duties starting March 1, 2016.

Beginning March 1, 2016, the amendments to the exemption concerning the Special Business Activities for Qualified Institutional Investors as set forth under Article 63 of the Financial Instruments and Exchange Act of Japan (the Article 63 Exemption) will become effective, and all existing filers under the Article 63 Exemption (Article 63 Exemption Operators) must comply with the amendments to the Article 63 Exemption (Amendments). The Amendments provide a six-month grace period (Grace Period) with respect to certain new requirements.

Please see our previous LawFlashes for background on this topic: Proposed Amendments to the Article 63 Exemption of the FIEA of Japan, Japan FSA Publishes Draft Enforcement Orders, Cabinet Ordinances, and Supervisory Guidelines for Article 63 Exemption, and Japan FSA Finalizes Amendments to the Article 63 Exemption. Each LawFlash covers topics of immediate interest to clients located in foreign jurisdictions that primarily target Qualified Institutional Investors (QIIs) with respect to their capital-raising activities in Japan.^[1]

This LawFlash is the fourth in a series of alerts that we have issued about the Amendments. Here, we provide guidance on what requirements existing Article 63 Exemption Operators need to comply with from March 1, 2016 (Effective Date), and what other requirements existing Article 63 Exemption Operators must meet during the Grace Period.

Self-Offering

In principle, after the Effective Date, all existing Article 63 Exemption Operators will be subject to the Amendments (except those specifically described in sections III and IV below), even where Article 63 Exemption Operators have begun their “self-offering” in Japan before the Effective Date. The below new obligations set forth in the Amendments will be applicable to any Article 63 Exemption Operator that engages in “self-offering” activities subsequent to the Effective Date.

New Duties and Prohibited Activities

In addition to the current prohibition against providing false statements and loss compensation to Japan investors, Article 63 Exemption Operators will be subject to various additional duties and prohibitions under the Amendments. By operation of the Amendments, the guidelines that govern the marketing conduct for Article 63 Exemption Operators will be roughly equivalent to those guidelines for Financial Instruments Business Operators under the Financial Instruments and Exchange Act of Japan (FIEA).

For many offshore Article 63 Exemption Operators, similar to the case of a Financial Instruments Business Operator, several of the new guideline items under the Amendments (such as the requirement for a suitability check and the delivery of explanatory documents on or before an agreement’s execution) will not be applicable to Article 63 Exemption Operators if such Article 63 Exemption Operator is engaging in self-offering marketing activities directed at QIIs.

Article 63 Exemption Operators that market to QIIs should particularly note that they will be subject to the following prohibitions in relation to their marketing activities after the Effective Date:

1. Prohibition against making conclusive statements regarding uncertain matters

2. Prohibition against making any type of solicitation regarding the interests of a limited partnership fund (LP Fund), if the assets of the LP Fund are not properly segregated from the proprietary assets of the Article 63 Exemption Operator

3. Prohibition against making any type of solicitation where the funds invested by the investors are misappropriated

Given the nature and content, we do not believe that these additional prohibitions will be particularly relevant or affect the current marketing activities of existing Article 63 Exemption Operators that market to QIIs only.

Record-Keeping Obligations

After the Effective Date, existing Article 63 Exemption Operators will be required to prepare the following records and maintain them for 10 years:

1. The “Japan Investor Ledger” (kokyaku kanjo motocho) that describes the name of the Japan limited partner, subscription date, name of the relevant LP Fund, number of interests subscribed, unit price and subscription amount, issue date of the LP Fund’s relevant interests, and credit, debit, and balance in the fund

2. The “Transaction Record” (torihiki kiroku) that describes the name of all Japan limited partners, name of the LP Fund, manner of offering of the LP fund, and particulars of orders accepted and executed (e.g., number of interests, unit price, and the amount and date of the orders accepted and executed)

These records can be prepared and maintained in English. In addition, they only need to be maintained with respect to the Article 63 Exemption Operator’s Japan investors or in relation to any solicitation activities conducted in Japan.

Self–Asset Management

After the Effective Date, existing Article 63 Exemption Operators must conduct their self–asset management activities in a manner that complies with the Amendments’ terms. However, existing Article 63 Exemption Operators will be continuously able to provide self–asset management services to existing clients based on the pre-Amendment rules, so long as the relevant invested assets have already been contributed (or committed) in accordance with a subscription agreement before the Effective Date.

New Duties and Prohibited Activities

With respect to self–asset management, Article 63 Exemption Operators will be subject to the Amendments and must comply with all the rules applicable to registered investment managers in Japan, including the duty of loyalty, the fiduciary duty of care of a good manager, and certain prohibited activities as set forth under Article 42-2 of the FIEA (e.g., self-dealing, engaging in “cross trades” and trades that have commercial terms that are disadvantageous to investors, or terms that are different from terms in a normal trade, etc.).

As discussed above in relation to self-marketing activities, an Article 63 Exemption Operator that provides self–asset management activities to QIIs will be exempt from certain duties and obligations (such as delivery of an investment management report in accordance with Japan laws).　

Record-Keeping Obligations

When engaging in “self–asset management,” Article 63 Exemption Operators must prepare and maintain certain statutory books and records for 10 years. Such statutory books and records include (i) the Limited Partnership Agreement, or any other agreement that authorizes the Article 63 Exemption Operator to manage the assets contributed by the investors; (ii) a copy of the investment management report (unyo houkokusho, Management Report) with respect to each management period of the LP Fund^[2]; and (iii) the Investment Management Detail Sheet (unyo meisaisho) with respect to the relevant assets under management by the Article 63 Exemption Operator.

These records do not need to be prepared in Japanese and only need to be maintained with respect to the Japan limited partners of the LP Fund.

We understand that each offshore Article 63 Exemption Operator will have its own record system required by the laws of its home jurisdiction; however, under the Amendments, Article 63 Exemption Operators must maintain their records in relation to the Japan limited partners in accordance with the Amendments. Based on the foregoing, Article 63 Exemption Operators (or the fund administrator to which Article 63 Exemption Operators outsources record keeping) may be required to make adjustments to their current record-keeping/reporting system to ensure compliance with the Japan-specific requirements under the Amendments. Thus, we recommend that Article 63 Exemption Operators take steps to review their existing record-keeping/reporting systems.

Considerations During the Grace Period

Additional Notification Under the Amendments

By the end of the Grace Period (i.e., August 31, 2016), existing Article 63 Exemption Operators must meet all new requirements under the Amendments and must also notify the Japan regulators of certain items by filing a new form of Article 63 Notification. The new form requires disclosure of significantly more information, such as (i) the name and address of the office where the Article 63 Exemption Operator actually conducts its business, (ii) a description of relevant investment portfolios of the LP Fund, and (iii) the name, type, and number of all QIIs.

In addition, various new deliverables must be submitted in connection with the new forms of the Article 63 Notification, including but not limited to the following: (i) an oath of the Article 63 Exemption Operator, its officers, and employees regarding certain qualification criteria^[3]; (ii) the constitutional document of the Article 63 Exemption Operator; and (iii) the corporate registration of Article 63 Exemption Operator. Because an offshore Article 63 Exemption Operator will be disqualified from relying on this exemption if such operator does not appoint a representative in Japan,^[4] we recommend that each offshore Article 63 Exemption Operator take steps to ensure that it meets all requirements during the Grace Period so that it may continue to operate under the Article 63 Exemption.

After filing the above new form Article 63 Notification, Article 63 Exemption Operators must, without delay, make certain registered information available to the public in an appropriate manner so that its Japan investors can always easily access and review such information (such as by maintaining such information at each of their offices or posting such information on their website). 

Article 63 Exemption Operators that have yet to update their existing Article 63 Notification to the new form may continue to make amendments and revise their notification using the current forms. However, once an Article 63 Exemption Operator has adopted the new form, any further amendments and revisions to their notification must be made using the new form.

Possibility of Relying on Other Exemptions or Arrangements

In practice, many Article 63 Exemption Operators have elected to file under the Article 63 Exemption even when such filing may not have been strictly necessary in light of the relevant facts. Typically, general partners of an LP relied on the Article 63 Exemption to give them greater flexibility with respect to their marketing activities in Japan and viewed the exemption as reasonable in light of the minor cost and low administrative burdens. However, with the Amendments, the Article 63 Exemption is a much more complicated filing with materially burdensome ongoing obligations, some of which are on par with those obligations of registered Financial Instruments Business Operators in Japan. Considering these factors, we recommend that all existing Article 63 Exemption Operators use this opportunity to reexamine their existing business activities with respect to Japan to confirm if they need to continue to operate under the Article 63 Exemption.

The Article 63 Exemption covers two specific registered activities: “self-offering” and “self–asset management,” and each Article 63 Exemption Operator should confirm that it is in fact still engaging in such activity. For example, if an LP Fund is closed for investment or if a Type 2 Financial Instruments Business Operator has been retained, it is quite possible that the Article 63 Exemption Operator will take the position that it is not engaging in “self-offering.” Similarly, if an LP Fund does not have any Japan investors or if the composition of the Japan investors permits the use of the “de minimis exemption”^[5] while the Article 63 Exemption Operator engages in “self–asset management” activities, the Article 63 Exemption Operator will not be required to be licensed or exempted under the Article 63 Exemption to engage in such activities. In light of these examples, particularly with respect to those LP Funds that are now closed for investment, we recommend that Article 63 Exemption Operators do a careful factual analysis of their activities to determine whether they are currently engaging in either “self-marketing” or “self–asset management” activities. In some cases, after such careful review, Article 63 Operators may decide to withdraw from the Article 63 Exemption regime.

Amendments to Business Reports and Publication of Explanatory Documents

Article 63 Exemption Operators must prepare a business report as set forth under the Amendments (jigyohokokusho, Business Report) from the beginning of their business year following the Effective Date (i.e., March 1, 2016). For example, if the business year of an Article 63 Exemption Operator started January 1 and ended December 31, such Article 63 Exemption Operator would be required to prepare a business report for the business year starting January 1, 2017, and ending December 31, 2017 (and the deadline of such business report is March 31, 2018).

Article 63 Exemption Operators will also be required to make a copy of the Business Report (or an explanatory document that is prepared by extracting certain information from the Business Report) available to the public in an appropriate manner whereby Japan investors can “always and easily” access and review such information (such as maintaining the relevant document at each of their offices or by posting the document on their website). Because the Business Report under the Amendments will be required from the business year starting after the Effective Date, in the preceding case, such documents must be published no later than April 30, 2018.

_{[1] One of the major points of the Amendments is limited to the scope of non-QIIs. If one intends to market funds to non-QIIs, please note that additional requirements and considerations are required to be qualified as the Article 63 Exemption under the Amendments. The types of non-QII permitted to subscribe to a limited partnership fund where the general partner is operating under the Article 63 Exemption will be limited to the certain types of investors, including but not limited to the following:
(i)    Subsidiaries or affiliates of any financial instruments business operator registered with the Japan FSA (e.g., Type 1 or Type 2 Financial Instruments Business Operator, Discretionary Investment Manager, or Investment Adviser/Agent)
(ii)   An entity that engages in the self-offering or self-asset management of a limited partnership fund for which such entity is acting as the general partner (a Fund Manager)
(iii)  A person who has a close relationship with a Fund Manager (e.g., an officer, an employee, family members, a parent company, a subsidiary, a subdelegatee, or an investment adviser)
(iv)  A listed company (including its subsidiaries and affiliates)
(v)   An entity that has capital amount or net assets of not less than JPY50 million (including its subsidiaries and affiliates)
(vi)  A government affiliated corporation (tokushu houjin) and an independent administrative institution (dokuritsu gyousei houjin)
(vii) A special-purpose company incorporated under the Act on Securitization of Assets (tokutei mokuteki kaisha)
(viii)    An employee’s pension fund (sonzoku kousei nenkin kikin) or corporate pension fund (kigyou nenkin kikin) that is expected to hold the investment assets (as defined by the regulations) of JPY10 billion or more and meets certain other requirements
(ix)  A foreign entity
(x)   An individual who is expected to hold investment assets (as defined by the regulations) of JPY100 million or more and who has maintained his or her account for securities and/or derivative trading for more than a year}

_{[2] Article 63 Exemption Operators that deal only with QIIs do not need to prepare and deliver investment management reports with respect to each management period of the LP Fund as long as those Article 63 Exemption Operators establish the system to quickly respond to any questions regarding the information that should be described in the Management Report. Therefore, Article 63 Exemption Operators will prepare and maintain such information equivalent to a copy of the Management Report.}

_{[3] A filer is required to state in the oath that the filer is not disqualified as an Article 63 Exemption Operator. Also, the filer’s officer and employee are required to state in the oath that each of them is not incompetent and not a member of antisocial forces.}

_{[4] Although offshore Article 63 Exemption Operators will be required, by the end of the Grace Period, to have any office in a jurisdiction where the Japan regulators have a Memorandum of Understanding with such regulators, existing Article 63 Exemption Operators are excluded from this requirement.}

_{[5] Article 16(1)(xiii) of the Cabinet Office Ordinance concerning the Definitions Specified in Article 2 of the FIEA. If (i) the direct investors of the limited partnership are QIIs or Article 63 Exemption Operators, (ii) the indirect investors of the limited partnership are QIIs, (iii) the total number of the direct investors and the indirect investors is less than 10, and (iv) the total amount of assets contributed by the direct investors does not exceed one-third of the total assets under management of the limited partnership, such business are excluded from the scope of the Financial Instruments Business.}

_{- See more at: https://www.morganlewis.com/pubs/the-effect-of-article-63-amendments-on-existing-article-63-exemption-operators#sthash.BwHMoYbG.dpuf}