Matthew Burgoyne is an associate and head of the fintech practice group, and Ryan Franzen is partner for securities and fintech, at McLeod Law in Calgary, Alberta.
Unlike within the us , Canada’s securities laws fall under the domain of the provinces. Arguably no area of provincial law has seen more activity as a results of the crypto boom than law , mainly thanks to the arrival of initial coin offerings (ICOs).
On Aug. 24 of last year the Canadian Securities Administrators (an umbrella organization of Canada’s provincial securities regulators) published CSA Staff Notice 46-307 on cryptocurrency offerings, during which the authors posit that “[A] coin/token should be a ‘security’ as defined in securities legislation of the jurisdictions of Canada. Businesses should complete an analysis on whether a security is involved.”
The Staff Notice goes on to verify that Canada, through the seminal Pacific Coast Coin Exchange v. Ontario Securities Commission decision, has adopted the United States’ Howey Test in determining whether a specific investment constitutes an investment contract and thus a security.
Although the authors of the Staff Notice admit that “Every ICO/ITO is exclusive and must be assessed on its own characteristics,” we believe provincial securities regulators in Canada wouldn’t take a radically different approach than the U.S. Securities Exchange Commission in analyzing whether tokens and coins are securities.
We believe the provincial securities regulators in Canada would be as equally inquisitive and systematic because the SEC has reportedly been in its recent analysis of straightforward Agreement for Future Tokens (SAFT) contract based coin and token offerings. Indeed there’s evidence that similar investigations have begun in Canada.
An issuer selling tokens in an ICO to Canadians would definitely have its work cut out for it in attempting to argue it had been actually selling utilities, commodities or licenses to use some kind of yet-to-be developed platform.
There are variety of examples in Canadian case law where issuers were attempting to sell “utilities” or something almost like modern-day tokens and coins, where the court simply didn’t buy the argument.
The Furtak decision
Take for example the 2016 Ontario Securities Commission (“OSC”) decision of Furtak. The issuers during this case were selling licenses to use relatively complex financial software agreements which granted users the proper to use the financial software to trade futures contracts.
However, as a part of the arrangement, the “users” would then contract with an affiliate of the issuer to work the software. Users didn’t share in any profits or losses as a results of the utilization of the trading software but received certain trade report fees. In effect, users paid a license fee in expectation of generating a return through no effort of their own.
The issue for the securities regulators was, were the licenses investment contracts or something else, like a group of contracts that created a business? The OSC ultimately found that the licenses were investment contracts.
In arriving at its decision, it noted that:
“[T]he salient feature of a securities transaction is that the public solicitation of risk capital to be utilized in a business enterprise…this subjection of the investor’s money to the risks of an enterprise over which he exercise no managerial control is that the basic economic reality of a security transaction.”
The nature of the commercial enterprise can vary to an outsized extent. because the OSC noted, investment contracts are found in Canadian and U.S. cases in arrangements as diverse because the use of solar panels, in proprietary software that might generate profits supported volatility, in fractional interests in death benefits of life assurance policies, in dental services sold by the promoter under sales agency agreements, in arrangements to share within the ownership and revenue from blood alcohol testing machines in pubs and even in payphones (remember those?).
The fact is, existing Canadian securities laws would probably already categorize most ICO tokens and coins as investment contracts, regardless of how novel and supposedly unique they’re . Some would argue the courts have seen it all before.
Provincial regulators in Canada have a minimum of shown a willingness to figure with crypto entrepreneurs, but so far the sole published examples we’ve of where this cooperation occurred was when those entrepreneurs accepted the very fact that their coins were securities and proceeded to maneuver forward with the regulators thereon basis. Even then the relief granted from securities laws was limited at the best .
Around the time of the publication of the OSC Staff Notice, variety of provincial securities regulators granted limited relief from dealer registration requirements under securities laws where coins issued in an ICO were offered as securities.
For example, in August 2017, the responsible-investing firm Impak Finance Inc. received limited relief from certain registration requirements in conjunction with its ICO by the Autorité des marchés financiers in Quebec. Two months later, the OSC granted similar relief in conjunction with an ICO by Tokenfunder Inc., a corporation established to, among other things, facilitate the issuance of third party coins and tokens.
In our opinion, the 2 aforementioned examples demonstrate that where coins are issued in an ICO not only might they be treated as securities, but if exemptive relief from some securities laws is granted by a securities regulator, the relief won’t be dramatic or earth shattering.
The parameters that have accompanied the exemptive relief within the se cases appear excessively obstructive to some in the crypto community, and should simply serve to spotlight the scope of the jurisdiction of the securities regulators and therefore the difficulties which arise given the appliance of securities laws.
For example, in both cases, each purchaser within the ICO is prohibited from purchasing quite $2,500 worth of coins (unless detailed know-your-client and suitability reviews on the purchaser are conducted) and Impak and Tokenfunder are restricted from listing and trading their coins on any cryptocurrency exchange unless prior approval is obtained from their respective provincial securities regulators.
Further, the coins in each ICO are subject to resale restrictions under law which impose a reasonably stringent hold period where further trading and transfer of the coins are prohibited indefinitely (unless certain rigid criteria are met). this might be frustrating to some as certain coins and tokens got to be freely traded on the blockchain by many various participants so as to satisfy their intended purpose.
Despite the exemptive relief from dealer registration requirements provided by the securities regulators in these decisions, issuers should bear in mind that under applicable Canadian securities laws an individual is merely required to register as a dealer if they’re engaging in or holding themselves out as engaging within the business of dealing in securities. Consequently, if an issuer isn’t “in the business”, then registration isn’t required, nor would exemptive relief from dealer registration requirements be necessary.
Simply because an organization has issued shares in an initial public offering (IPO) to boost capital to fund its business, and people shares are listed on a stock market , doesn’t mean the corporation is within the business of dealing in securities.
By extension, just because a coin is issued in an ICO and subsequently traded on the blockchain doesn’t necessarily mean the issuer of the coin is within the business of dealing in securities. In fact, unlike shares of an organization , at the time a coin is traded on the blockchain, it’s going to have its intended utility and essentially lost any security characteristic it initially had.
All told, ICO promoters should exercise caution in Canada when attempting to plug a utility token inconsiderately of securities laws.
Further, if you’ve come to simply accept that your token is an investment contract, then supported these decisions, expect to be treated like all other issuer of securities.
The authors would really like to acknowledge Amanpreet Sran for her research, contributions and assistance with this text .