The Canadian Securities Administrators (CSA), a body comprised of the securities regulators from Canada’s ten provinces and three territories, has finally taken a position on cryptocurrency. On August 24, 2017, it published CSA Staff Notice 46-307 Cryptocurrency Offerings (the “Notice”). The Notice provides the most extensive policy outline yet from the CSA on how current securities law requirements may apply to initial coin offerings (ICOs), initial token offerings (ITOs), cryptocurrency investment funds, and cryptocurrency exchanges.
The Notice follows two other pronouncements from securities regulatory bodies earlier this year: a press release dated March 8, 2017 from the Ontario Securities Commission which advised businesses that the use of distributed ledger technologies, such as blockchain, as part of their financial products or service offerings, may make them subject to Ontario securities laws; and an investigative report in the United States by the Securities and Exchange Commission issued on July 25, 2017 which concluded that in one case, tokens offered in an ITO were securities and subject to the applicable federal securities laws of the United States.
Rather than treating cryptocurrencies as a novel phenomenon requiring new securities laws, the Notice asserts that existing Canadian securities laws are well suited to deal with cryptocurrency offerings, markets and their participants.
IS CRYPTOCURRENCY A SECURITY?
The Notice addresses the fundamental question of whether a cryptocurrency is a security. The Notice makes it clear that simply because an instrument is called a “coin” or “token” rather than a share, stock or equity, this is not a loophole that removes the instrument from the reach of securities regulators. In the Notice, the CSA states that each cryptocurrency is unique and it will require a review of substance over form to determine whether any securities laws have been triggered; but that in all cases, existing legislative frameworks will apply. For example, one type of security is an “investment contract.” In determining whether or not a cryptocurrency offering is an investment contract, issuers should apply the four-prong test, and ask whether the coin or token involves:
- an investment of money
- in a common enterprise
- with the expectation of profit
- to come significantly from the efforts of others.
The CSA’s position that a cryptocurrency may be a security has very broad implications for the cryptocurrency industry. In Canada securities must be offered with a prospectus or pursuant to an exemption from the prospectus requirement. Cryptocurrency coins or tokens, if determined to be a security, would need to be offered with a prospectus, a comprehensive disclosure document, or pursuant to an exemption from the prospectus requirement, such as to “accredited investors” only, to comply with securities laws. The Notice states that to date no issuer has used a prospectus to complete an ICO or ITO in Canada, although several have been completed pursuant to an applicable prospectus exemption.
TRADING IN CRYPTOCURRENCY
Existing securities laws regarding who may be permitted to trade securities may also apply to market participants trading in cryptocurrency. Businesses completing ICOs and ITOs may be deemed to be trading in securities for a business purpose (known as the “business trigger”) and could be required to register with the applicable securities commissions as “dealers” or qualify under an exemption from the dealer registration requirement. In particular, individuals or businesses who are in the business of trading in securities must meet dealer obligations to investors, including know-your-client (KYC) requirements.
The Notice also provides guidance on how cryptocurrency exchanges may be established in Canada. A cryptocurrency exchange is an online marketplace that facilitates the buying and selling of various cryptocurrencies. While no cryptocurrency exchange has been recognized to date in Canada, the CSA has stated that if an exchange were to conduct business in a jurisdiction in Canada, it would need to apply to that jurisdiction’s securities regulatory authority for recognition as an “exchange” or an exemption from recognition.
CRYPTOCURRENCY INVESTMENT FUNDS
The Notice recognizes that investment funds are being set up to invest in bitcoin and other cryptocurrencies. The Notice encourages a business looking to establish a cryptocurrency investment fund to consider the following issues in the context of existing securities laws: whether offering to retail investors is permissible, how to conduct appropriate due diligence on any cryptocurrency exchange that the fund may use to buy and sell cryptocurrencies, appropriate registration categories in respect of the investment fund, including dealer, adviser and/or investment fund manager, various valuation considerations of the fund’s portfolio, and how applicable securities laws relating to custody, meaning the holding of the portfolio’s assets by a custodian, will be met.
The CSA has taken the position that cryptocurrency offerings raise investor protection concerns. Factors like anonymity, lack of transparency, lack of regulation of exchanges and lack of investment expertise allow greater potential for fraud and unethical market practices. The CSA states that it has attempted to strike a balance between adapting to ever changing financial market innovation and facilitating corporate finance with ensuring fair and efficient capital markets and investor protection.
Businesses or investors seeking to participate in capital raising activities involving cryptocurrency should anticipate complying with existing securities laws. If you have questions about cryptocurrency offerings and related matters, contact any member of Clark Wilson LLP’s Capital Markets, Securities & M&A Group.