The CSA Notice 46-307 addresses a number of considerations of relevance to Fintechs, investors and their advisors, including the potential applicability of Canadian securities laws to initial coin offerings (“ICOs”) and initial token offerings (“ITOs”), cryptocurrency exchanges and cryptocurrency investment funds. It follows a press release issued by the Ontario Securities Commission earlier this year confirming that Ontario securities laws may apply to any use of distributed ledger technologies (“DLTs”), such as blockchain, as part of financial products or service offerings.
Effect of status as a ‘SECURITY’
- The CSA Notice clarifies that regardless of whether the instrument distributed is referred to as a coin/token generated from an ICO/ITO, instead of a share, stock or equity, that instrument may still be a “security” under Canadian securities laws. Security includes an “investment contract”, that is determined by a four-prong test; i.e., does the coin/token involve: (i) an investment of money (ii) in a common enterprise (iii) with the expectation of profit (iv) to come significantly from the efforts of others.
- The “investment contract” test looks at the economic realities of the circumstances and provides a very broad and flexible means of capturing new and innovative arrangements, such as ICOs/ITOs — that do not fit within other definitions of a “security”.
- Generally, “securities” offered to the public in Canada must be offered with a prospectus, which provides details of the venture and the securities being offered and is filed with the relevant securities commissions. An ICO/ITO of a coin/token that constitutes a “security” requires either the filing of a prospectus or the use of an applicable prospectus exemption.
- To date, no business has used a prospectus to complete an ICO/ITO in Canada; however, coins/tokens have been distributed in Canada on a prospectus exempt basis.
- Canada having amended the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (Canada) in 2014 to include within the scope of money services businesses “dealers in virtual currencies” regulating the cryptocurrency exchanges and marketplaces, particularly with respect to anti-money laundering, recordkeeping, counter-terrorist financing, and identity verification requirements.
- In addition, in Quebec, the Autorité des marchés financiers require such exchanges and virtual currency ATMs to be licensed as money services businesses.
- While no cryptocurrency marketplaces or exchanges have registered with securities regulators in Canada to date, CSA Staff emphasizes the need for cryptocurrency exchanges to determine whether the cryptocurrencies that they offer are “securities” and, if so, to register as a marketplace or get an exemption from registration
Dealer Registration Requirement
- Businesses that undertake an ICO/TO for a business purpose may be required to register as a dealer or get an exemption from registration. The factors to be considered include whether a security is involved, a broad base of investors is being solicited, whether a considerable amount of capital is being raised from a large number of investors, the use of public forums (i.e., the internet) and participation in public events to market the sale of coins/tokens.
- Any businesses that meet the business purpose must fulfill know-your-client and suitability requirements and other on-going registrant obligations.
- Platforms used for trading coins/tokens that are securities may constitute a marketplace and therefore must comply with marketplace requirements or otherwise seek an exemption from such requirements. Any platform used for offering coins/tokens that constitute securities must have policies and procedures, including in respect of cybersecurity matters, in place.
Cryptocurrency Investment Funds
- A cryptocurrency investment fund should register in the category applicable to it as an investment fund manager and/or adviser, or dealer.
- The fund should consider the method of valuation of the cryptocurrencies and securities included in the fund’s portfolio, whether this method will be assessed in an independent audit and how the exchange of cryptocurrency will take place. Any exchange used to purchase or sell cryptocurrencies will have to be subject to due diligence by the fund.
- Where retail investors invest in the fund, some jurisdictions in Canada will not accept an offering on an exempt basis in reliance upon the offering memorandum prospectus exemption, and instead will require compliance with the prospectus requirement, investment suitability, and investment fund regulations.
- Finally, any custodian that holds the portfolio assets of a cryptocurrency investment fund must have cryptocurrency-related expertise.