Evan Thomas, Blair Wiley
Jun 13, 2018
On June 11, 2018, the Canadian Securities Administrators (CSA) published a further Staff Notice [PDF] regarding the securities law implications of initial coin offerings and initial token offerings (generally referred to by the CSA as token offerings). This guidance amplifies previous warnings by Canadian securities regulators that most token offerings are subject to Canadian securities laws and that regulators will continue to take enforcement action against projects and businesses that engage in token offerings without complying with applicable securities laws.
- The Staff Notice sends a clear signal that Canadian securities regulators are monitoring the crypto-asset space very closely and understand commonly used token offering models, including structures that may have been adopted to minimize the application of Canadian securities laws. In particular, by explicitly addressing offerings via Simple Agreement for Future Tokens (SAFTs), through air drops or from foreign jurisdictions, the Staff Notice signals that regulators believe projects using these structures could nonetheless be subject to Canadian securities laws.
- The CSA’s approach is generally consistent with the approach taken by the U.S. Securities and Exchange Commission (the SEC), namely, that most token offerings are subject to applicable securities law. Further, consistent with statements by the SEC, the CSA is clearly directing a message at lawyers and other professional advisors to ensure that clients receive appropriate advice regarding intended token offerings.
- The Notice arguably over-emphasizes token purchasers’ reasonable expectation of profit in acquiring tokens as an indicator that offering is an investment contract. One of the innovations of crypto-currency is the creation of economic incentives for participation in a protocol or platform in a way that benefits the network or collective. Bitcoin, for example, exists only because miners have an incentive to validate transactions and in the process, secure the network. Respectfully, an expectation of profit should not be determinative in a securities law analysis; otherwise, securities regulators would have jurisdiction over any investment in any tangible or intangible asset that is made with an expectation of profit.
- There is no suggestion that new regulation will be forthcoming to address token offerings. The implication is that CSA members expect Canadian businesses undertaking projects involving tokens to engage with counsel and regulators at an early stage and to comply with existing regulatory requirements (to the extent they apply to token offerings). This will undoubtedly frustrate many in the industry who regard the regulatory sandbox and exemptive relief model as undesirable and would prefer more clearly defined and tailored approaches to the regulation of token offerings.
Indicators of an “investment contract”
The Staff Notice identifies a number of situations that may indicate that the token offering is an “investment contract” subject to securities laws, including:
- The token is for use in a platform that is still under development.
- The token is not immediately delivered.
- The issuer offers free tokens or other benefits to promoters of the offering.
- The stated purpose of the offering is to raise capital to develop the platform or support the value of the token.
- Management of the issuer retains a significant number of unsold tokens as compensation.
- The issuer suggests the tokens can be a currency or have broad utility, but there is no evidence of widespread adoption.
- Management of the issuers suggests they have special expertise that will increase the value of the token.
- There is a fixed supply of tokens or access to tokens will be limited in some fashion.
- The issuer permits purchases of tokens in excess of the purported utility of the token.
- Marketing of the offering targets purchasers who would not reasonably be expected to use the platform or product.
- Management states or implies that the tokens will increase in value, or encourages others to make such statements.
- There is a reasonable expectation that the tokens will trade on a crypto-asset trading platform or will otherwise be freely tradeable.
The Staff Notice puts particular emphasis on trading in the secondary market. CSA staff will examine white papers and statements in other media, such as messaging platforms, community meetups and online videos for messaging regarding secondary trading of tokens. In addition, CSA staff will take into account third-party representations concerning secondary trading that have been explicitly or implicitly endorsed by the issuer or management.
The Staff Notice also identifies certain factors that may indicate that the offering is not an investment contract:
- Tokens are distributed for free, though this is stated with the proviso that a distribution of free tokens as part of an overall sale of an ancillary product or service may involve an investment of money and be characterized as a security.
- The tokens are not fungible and have unique characteristics.
- A continuous or unlimited supply of tokens.
- The tokens have a fixed value that does not change with time or changes based on non-commercial factors.
CSA staff emphasize, however, that each offering must be analyzed on its own facts and none of the above factors is determinative as to whether an offering is, or is not, an offering of securities.
Other key themes
- Utility tokens – The Staff Notice states that “most of the offerings of tokens purporting to be utility tokens that we have reviewed to date have involved the distribution of a security, namely an investment contract.” A token may have utility and also be a security.
- Definition of “security” – A token may fit within other branches of the definition of “security” under securities legislation, not just the widely cited “investment contract” branch.
- SAFTs and multiple step transactions – With respect to SAFTs and other multi-step transactions involving tokens, tokens delivered at subsequent steps may be a security, even if they have “utility,” because they continue to have features of an investment contract or have other security-like attributes. The Staff Notice expressly states that the CSA “will have concerns where a multiple step transaction is used in an attempt to avoid securities legislation.”
- Legal counsel and Regulatory Sandbox – The Notice encourages businesses with proposed offerings of tokens to consult qualified legal counsel. The Notice also encourages businesses to contact Canadian securities regulators through the CSA Regulatory Sandbox.
- Jurisdictional issues – The Staff Notice notes that securities law requirements may apply to token offering activities “regardless of where investors are located.” It emphasizes that Canadian securities regulators may have jurisdiction over transactions involving investors outside of their jurisdictions where there is a “real and substantial connection” between the transaction and Canada.
- Ongoing enforcement activity – The Notice advises that CSA members are actively investigating token offerings to identify “past, ongoing and potential future violations of securities laws or conduct in the capital markets that is contrary to the public interest.”