A panel of the Ontario Securities Commission (OSC), consisting of a single commissioner, recently ordered that a prospectus receipt be issued for a new Bitcoin Fund (the Fund) managed by 3iQ Corp. (the Manager), overruling an earlier decision by the Director of the Ontario Securities Commission’s Investment Fund & Structured Products branch (the Director).

The decision clears the way for Canadian investment in this publicly traded bitcoin fund, potentially encouraging other funds or issuers seeking to offer exposure to novel industries and asset classes. It also challenges the recent trend of expansive interpretation of the “public interest” under securities legislation, offering a more restrictive interpretation.

Background

In October of 2018, the Manager filed a non-offering preliminary prospectus on behalf of the Fund. As stated in the prospectus, the Fund intended to invest in long-term holdings of bitcoin purchased from various sources, including bitcoin exchanges, to provide its investors with exposure to bitcoin and the daily price movements of the US dollar price of bitcoin, and the opportunity for long-term capital appreciation.

On February 15, 2019, the Director determined that it would be contrary to the public interest to issue a receipt for the Fund’s preliminary prospectus for multiple reasons, including:

  • concerns that bitcoin is an illiquid asset, in contravention of the requirement under National Instrument 81-102 – Investment Funds (NI 81-102) against the holding of illiquid assets;
  • difficulty in valuing the Fund’s assets as a result of the fragmented and unregulated environment in which bitcoin generally trades;
  • the difficulty the Fund’s sub-custodian would face in providing customary reports on the design of its controls and ability to operate as intended over a defined period of time; and
  • the lack of clarity as to how the Fund’s auditor would be able to provide an unqualified opinion on its annual financial statements in accordance with Canadian securities laws.

On March 15, 2019, the Manager and the Fund made an application to the OSC seeking an order to set aside the decision of the Director to refuse to issue a receipt and to direct the Director to issue a receipt.

Decision

The panel considered each of the grounds put forward by OSC Staff (Staff) for refusing a receipt in turn:

  1. Liquidity
     NI 81-102 imposes restrictions on the amount of illiquid assets that a non-redeemable investment fund can hold or purchase. In brief reasons on this point, the panel found that there was sufficient evidence of trading in bitcoin for it to be considered a liquid asset, including trading on regulated exchanges.
  2. The Public Interest
     The bulk of the panel’s reasons were devoted to considering public interest grounds. Section 61 of Ontario’s Securities Act (the Act) allows a receipt to be refused where, among other things, the prospectus does not comply in any substantial respect with any of the requirements of the Act or the regulations, or where appears that it is not in the public interest to issue a receipt.

In addressing Staff’s concerns about valuation and market manipulation, the panel noted that the Fund will invest in bitcoin, not in all crypto-assets; would pursue a buy and hold strategy; and trade Bitcoin only on regulated exchanges. These features would mitigate concerns about liquidity and abusive practices.

The panel also distinguished the facts before it from recent US cases in which the Securities and Exchange Commission refused to allow bitcoin exchange traded funds (ETFs), given that the Fund would only report pricing monthly and provide for potential redemption yearly (unlike an ETF which requires daily trading and reporting), lessening the potential adverse impacts of market manipulation. 

The panel concluded that Staff had not sufficiently shown that the bitcoin held by the Fund would be inadequately safeguarded, given the Fund’s use of qualified custodians and other protective measures.

The panel then turned to the consideration of the public interest, seeking to resolve the tension between two fundamental principles of the Act: investor protection and fostering fair and efficient capital markets.

The panel also made it clear it did not necessarily agree with Staff that the public interest extends to a consideration of the assets a fund proposes to hold or the markets in which those assets trade. The panel found that, in effect, Staff were proposing an indefinite ban on any fund holding bitcoin—an asset investors could already acquire through other means—until the market sufficiently matures, without providing any authority for doing so. The panel went on to note that investor protection under section 61(1) is most often concerned with the issuer and matters that are within the issuer’s control, and less concerned with extraneous or external forces. 

In the panel’s words, “it is not the job of securities regulators to ban speculation or risk taking” and the public interest jurisdiction is “broad, but it is not infinite.”

Implications

In coming to its decision, the panel drew a distinction between the “front door” to the capital markets and the “back door” (i.e. reverse takeovers, which do not require a prospectus receipt), stating that “the notion of professionalizing investing in risky assets to mitigate risks should be encouraged, not discouraged… the Applicants have come through the front door for prospectus review and approval, and this behaviour should be encouraged.” The panel noted that there were already approximately ten reporting issuers offering crypto exposure in Ontario that had gone public through reverse takeovers,

In the immediate term, the decision may encourage more issuers and investment funds to try walking through the “front door.” However, the panel was clear that not just any fund or issuer is entitled to a receipt. The decision suggests, for instance, that bitcoin ETFs (requiring daily net asset value determination) or other funds that have taken less active and rigorous measures than the Fund to mitigate the risks associated with cryptocurrencies might still be denied receipts. The front door may be open, but only a crack.

The decision also marks an interesting—and seemingly rare—recent restraint on the use of the public interest powers afforded to OSC Staff throughout the Act. These powers include the broad power under section 127 that allows a variety of orders even where there has been no violation of securities law, if in the OSC’s opinion “it is in the public interest.”

Even by the standards of Canadian statutes, the “public interest” powers under the Act are quite broad, particularly in light of the range of actions they allow for. While used throughout the Act, the term “public interest” is never defined.

The case law has rushed to fill that vacuum. Earlier section 127 cases like Re Canadian Tire Corp.1required that conduct be “clearly abusive” to violate the public interest. Yet recent decisions such as Re Biovail Corp.2have deemed it sufficient in certain circumstances that conduct engage the “animating principles” of the Act. While it is not clear the decision will have a wider impact on the “public interest” jurisprudence, it certainly marks a departure from this prior line of decisions. 

The case occurs in a broader context of trying to reduce the burden for reporting issuers and investment funds, through various “burden reduction” projects securities regulators in Ontario have undertaken. In that respect, the decision is a welcome recognition that the wider goal of investor protection is not necessarily served by forcing products like the Fund—and other issuers and funds offering exposure to new industries and asset classes—outside the highly regulated system for prospectus offerings to the public.

Footnote

1 (1987), 10 O.S.C.B. 857 (affirmed (1987), 59 O.R. (2d) 79 (Div. Ct.), leave to appeal to Ont. C.A. refused (1987), 35 B.L.R. xx).

2 (2010), 33 O.S.C.B. 8914.

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