This article was co-authored by Caitlin Choi, an articling student in the Toronto office.
Further to the Canadian Securities Administrator's (CSA) August 2017 Staff Notice (see our last update here), on October 17, 2017, the Ontario Securities Commission (OSC) granted an exemptive relief application with respect to the dealer registration requirements imposed by Ontario securities laws in order to permit an initial coin offering (ICO) by Token Funder Inc. (Token Funder), a Toronto-based blockchain technology company.
Token Funder was established to create a smart token asset management platform (STAMP), which is intended to, among other things, facilitate third-party issuers raising capital through the offering of blockchain-based securities. In addition, Token Funder also intends to provide token and coin management and governance services for issuers and, subject to regulatory approvals and / or exemptive relief orders, to facilitate token and coin transfers.
Token Funder will create an aggregate of 1 billion digital tokens through a smart contract on the Ethereum Blockchain (FNDR Tokens), 200 million of which will be offered to investors to fund the creation of its platform and subsequent transfers of FNDR Tokens, pursuant to available prospectus exemptions.
Unlike some ICOs, which provide coin holders no inherent rights, the FNDR Tokens will entitle the holders thereof to: (i) participate in the STAMP's future success, via distributions from Token Funder that result from the operation of its STAMP, if, as, and when determined by Token Funder's board, provided, that Token Funder is able to make such distributions without adversely affecting the STAMP; (ii) receive e-mail updates regarding the development of the STAMP, including the achievement of applicable milestones, audited financial statements and applicable disclosure required by applicable securities laws; and (iii) have certain voting rights in respect of the entities entitled to use the STAMP – although holders of FNDR tokens will not have voting rights in respect of Token Funder's governance or operation.
The OSC granted Token Funder exemptive relief for a period of 12 months with respect to the dealer registration requirements under Ontario securities laws, provided that, promptly following completion of the offering, Token Funder would seek to become a registrant and will not facilitate any capital-raising efforts through its STAMP prior to obtaining such status. The relief was granted pursuant to the CSA's regulatory sandbox initiative, which is designed to allow companies to obtain exemptive relief from securities laws that may be an impediment to innovative business models.
By allowing Token Funder to complete the offering in advance of registration, Token Funder is able to establish interest in its STAMP prior to devoting capital and resources to becoming a registrant. Notwithstanding the delay of the requirement, the OSC incorporated certain obligations to protect potential investors into the exemptive relief order, including:
- A prohibition on the provision of advice by Token Funder or its representatives to any investor with respect to the FNDR Tokens;
- A requirement for Token Funder to establish, maintain and apply policies and procedures that establish a system of controls and supervision sufficient to manage the risks associated with its business in accordance with prudent business practices, including the Ethereum Blockchain, cybersecurity and conflicts of interest between Token Funder and its investors;
- A requirement to provide full and complete disclosure to all prospective investors through an offering memorandum available on its website;
- A requirement to conduct know-your-client and suitability reviews for each investor, including a comprehensive onboarding process to ensure, among other things, that investors have a detailed understanding of cryptocurrency and digital token offerings; and
- A requirement to provide, in addition to any other reporting required by securities laws, the OSC with: (i) details of investor complaints received by Token Funder within 10 days of any such complaint, and (ii) quarterly reporting (within 10 days of the end of each quarter).
While the exemptive relief order granted in favour of Token Funder evidences the OSC's willingness to provide limited relief, it remains tied to a series of enhanced disclosure and reporting obligations. In addition, as with the exemptive relief granted to Impak Finance Inc. in connection with its ICO, the OSC made a point of emphasizing that its decision "should not be viewed as a precedent for other filers".
This decision comes in the wake of a global rise in popularity of ICOs over the past few years. More than $2.5 billion has been raised from ICOs in 2017 alone.1 As regulators in many jurisdictions continue to wrestle with the task of fitting blockchain technology within established regulatory frameworks, including securities laws, the CSA has expressed a desire to adapt the law to technological advances.
Both this decision and the decision released on August 16, 2017, in connection with Impak Finance Inc.'s ICO, provide a helpful indication that the CSA are willing to work with issuers to create a roadmap for ICOs. Notwithstanding the foregoing, the decisions do not ultimately address questions regarding the treatment of utility tokens under Canadian securities law. Going forward, as new tokens and coins continue to be brought to market, the blockchain community will be watching Canadian regulatory authorities closely to see how they strike a balance between encouraging innovation and protecting investors from fraudulent ICOs.
1. Coindesk ICO Tracker, October 13, 2017.
2. Alternatively, Forbes reported on September 23, 2017, that nearly 2.3 billion dollars have been raised in ICOs: Chance Barnett, "Inside the Meteoric Rise of ICOs", Forbes, September 23, 2017.
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