With the rise in popularity of cryptocurrency, many small fintech businesses have begun developing their own coins and tokens. This has led to a rise in Initial Coin Offerings (“ICOs”) and Initial Token Offerings (“ITOs”) as a means to raise investor funds to develop the coins/tokens. ICOs/ITOs can trigger registration and prospectus requirements under securities laws, and as such fintech companies should first consider applicable securities legislation.
ICOs/ITOs may involve securities
Each province in Canada has its own securities legislation, which has led to some differences in how a “security” is defined depending on the jurisdiction. However, securities legislation in every province includes “investment contracts” within their definition of a “security.”[1]
An “investment contract” is a catch-all term which is capable of applying to a broad array of contractual relationships. In Pacific Coast Coin Exchange v Ontario Securities Commission, the Supreme Court of Canada broadly defined an “investment contract” as: 1) an investment of money, 2) in a common enterprise, 3) with an expectation of profit, 4) to come significantly from the efforts of others.[2]
On August 24, 2017, the Canadian Securities Administrators (“CSA”) issued CSA Staff Notice 46-307 Cryptocurrency Offerings (“SN 46-307”), which noted that securities regulators have encountered many instances where the coins/tokens in question were securities as they fell within the scope of an “investment contract.”[3]
Potential registration requirements
Companies launching ICOs/ITOs which involve securities may be required to register as a dealer. Securities regulators will examine whether the company is trading securities with a business purpose to determine if it needs to be registered. This is called the “business trigger” test and is outlined in Part 1.3 of the Companion Policy to National Instrument 31-103 Registration Requirements, Exemptions, and Ongoing Registrant Obligations (“NI 31-103”).[4]
In the context of ICOs/ITOs, securities regulators have found the following factors to be important to an application of the business trigger test: 1) soliciting a broad base of investors; 2) using the internet to reach a large number of potential investors; 3) attending public events to actively advertise the sale of the coins/tokens; and 4) raising a significant amount of capital from a large number of investors.
Registrants are subject to a number of requirements under NI 31-103, including Know-Your-Client and suitability obligations.[5] Securities regulators have noted that fintech companies may be able to meet these obligations through the use of an automated online platform.[6]
Potential prospectus requirements
ICOs/ITOs may also engage the requirement to prepare and file a prospectus. While it can be very costly and time-consuming to meet prospectus obligations, exemptions from this requirement may be available under National Instrument 45-106 Prospectus Exemptions.[7] Issuers typically make use of the accredited investor or offering memorandum (“OM”) exemptions.
While some fintech companies have attempted to utilize the OM exemption through the publication of a whitepaper, securities regulators have warned that fintech companies should be careful to ensure that the whitepaper conforms to all of the disclosure requirements of an OM.[8]
The CSA Regulatory Sandbox
The CSA Regulatory Sandbox (“Sandbox”) was created to allow firms to register and/or obtain exemptions from securities requirements under a faster and more flexible process than a standard application. A fintech company, or their legal counsel, seeking exemptions from securities laws should consider advising their local regulator that they want to proceed via the Sandbox.[9]
Key takeaways:
- ICOs/ITOs may engage registration and prospectus requirements under securities laws;
- Exemptions from securities laws may be needed prior to launching the ICO/ITO; and
- Fintech businesses seeking exemptions from securities laws may want to proceed through the CSA Regulatory Sandbox to obtain an exemption in a faster, more flexible manner.
[1] Securities Act, RSBC 1996, c 418, s 1(1); Securities Act, RSA 2000, c S-4. 1(ggg); The Securities Act, 1988, SS 1988-89, c S-42.2, s 2(1)(ss); The Securities Act, CCSM, c S50, s 1(1); Securities Act, RSO 1990, c S.5, s 1(1); Securities Act, CQLR, c V-1.1, s 1(7); Securities Act, SNB 2004, c S-5.5, s 1(1); Securities Act, RSNL 1990, c S-13, s (1)(qq); Securities Act, RSPEI 1988, c S-3.1, s 1(1)(bbb).
[2] [1978] 2 SCR 112.
[3] Available online: https://www.osc.gov.on.ca/en/SecuritiesLaw_csa_20170824_cryptocurrency-offerings.htm#N_1_1_1_6_; also see CSA Staff Notice 46-308 Securities Law Implications for Offerings of Tokens, available online: https://www.osc.gov.on.ca/en/SecuritiesLaw_csa_20180611_46-308_securities-law-implications-for-offerings-of-tokens.htm.
[4] Available online: https://www.bcsc.bc.ca/securities-law/law-and-policy/instruments-and-policies/3-registration-requirements-related-matters/current/31-103/31103cp-registration-requirements-exemptions-and-ongoing-registrant-obligations-cp.
[5] NI 31-103, Parts 13.2 and 13.3.
[6] SN 46-307.
[7] Available online: https://www.bcsc.bc.ca/securities-law/law-and-policy/instruments-and-policies/4-distribution-requirements/current/45-106/45106-prospectus-exemptions-ni.
[8] SN 46-307.
[9] See the following for the application process: https://www.securities-administrators.ca/industry_resources.aspx?id=1588.
