On August 24, 2017, the Canadian Securities Administrators (CSA), an umbrella organization of Canada’s provincial and territorial securities regulators, released a Staff Notice regarding token offerings to help businesses understand the securities laws that they are obliged to follow.
The CSA acknowledged that, while token offerings offer businesses new opportunities to raise capital, they also raise concerns over investor protection, volatility, transparency, valuation, custody and liquidity, and regulation. In addition, unethical practices, scams, and a lack of understanding, may be harmful to investors. The notice was published in all Canadian jurisdictions but Saskatchewan; the Financial and Consumer Affairs Authority of Saskatchewan will separately advise on this matter after a provincial by-election on September 7, 2017.
The CSA said that many token offerings involve securities sales to which the laws of Canada apply if the business was conducted within Canadian borders or involved Canadian investors. As per the notice:
"Businesses should consider if and how prospectus, registration and/or marketplace requirements apply to their cryptocurrency offerings. Specifically and as described in more detail in this Staff Notice:
• Securities may only be sold after a receipt has been received from a securities regulatory authority for a comprehensive disclosure document called a ‘prospectus’, or pursuant to a private placement in reliance on a prospectus exemption;
• Businesses and individuals in the business of trading in or advising on securities must be properly registered or rely on an exemption from registration; and
• A platform that facilitates trades in coins/tokens that are securities may be a marketplace and need to comply with marketplace requirements or obtain an exemption from such requirements.
• Respond to requests from fintech businesses for guidance on the applicability of securities laws to cryptocurrency offerings and what staff will consider in assessing if an ICO/ITO is a distribution of securities;
• Discuss what steps fintech businesses can take if they are raising capital through ICOs/ITOs, so that they comply with securities laws;
• Highlight issues that fintech businesses looking to establish cryptocurrency investment funds should be prepared to discuss with staff;
• Discuss how the use of cryptocurrency exchanges may impact staff’s review of ICOs/ITOs and cryptocurrency investment funds; and
• Explain how the CSA Regulatory Sandbox can help fintech businesses with cryptocurrency offerings comply with securities laws through a flexible process."
The CSA reviewed various token offerings, and concluded that many of those tokens were securities because they were investment contracts. It said, "In arriving at this conclusion, we have considered the relevant case law, which requires an assessment of the economic realities of a transaction and a purposive interpretation with the objective of investor protection in mind."
The CSA offers a four-prong test for determining the existence of an investment contract:
"Does the ICO/ITO involve:
1. An investment of money
2. In a common enterprise
3. With the expectation of profit
4. To come significantly from the efforts of others"
The CSA acknowledges that no business has filed a prospectus to complete a token offering in Canada. However, it anticipates that businesses will seek to sell coins or tokens under exemptions by selling to "accredited investors."
The CSA also provided insight on the necessity for businesses to provide documentation in addition to whitepapers. The CSA said that while whitepapers may provide disclosure to investors, documents that comply with securities laws must also be supplied, such as offering memoranda and prospectuses.
The document provides additional guidance on civil remedies for investors, KYC requirements, and investment funds.
The CSA wants to encourage financial market innovation and facilitate fundraising by FinTech businesses while ensuring a fair market and investor protection. "As cryptocurrencies become more popular and mainstream, balancing the demand for new investment opportunities and the need to protect investors from high-risk or fraudulent activities is extremely important."