Canada: McMillan Advises On First Initial Coin Offering Granted Exemptive Relief By Canadian Securities Regulators

Co-authored by Simon Paransky, Summer Law Student

McMillan recently advised Impak Finance Inc. ("Impak") on the first initial coin offering ("ICO") to be granted exemptive relief, on August 15, 2017 by the Autorité des Marchés Financiers (the "AMF"). Similar in some ways to an initial public offering ("IPO"), ICOs are being used by financial technology ("fintech") businesses to issue cryptocurrency and raise funds for various purposes. On August 24, 2017, the Canadian Securities Administrators (the "CSA") published CSA Staff Notice 46-307Cryptocurrency Offerings (the "Staff Notice") to provide guidance on the applicability of securities laws to ICOs. The Staff Notice states that securities laws will apply to an ICO if it is an offering of a "security".1 The Staff Notice was published in all jurisdictions of Canada except Saskatchewan. It is expected that the Financial and Consumer Affairs Authority of Saskatchewan will advise of its approach to cryptocurrency after September 7, 2017.

Background

What is a cryptocurrency?

A "cryptocurrency" is a digital currency that is exchanged electronically. The cryptocurrency itself is represented by virtual 'coins' or 'tokens'. Unlike fiat currency which is issued by a government body, cryptocurrency is not issued by a central authority. At a basic level, cryptocurrencies are just entries on a distributed ledger with account numbers and balances (known as a "blockchain"). All transactions are recorded on the blockchain. There is no central authority keeping track of the blockchain – it is decentralized. Any user can keep track of the blockchain. To this end, the integrity of the blockchain is upheld by virtue of the many users keeping track of the same blockchain.

When users exchange cryptocurrency, a sender will send out a transaction message to the entire peer-to-peer network of computers (known as "nodes") including: (1) the sender's account number, (2) the recipient's account number and (3) the amount of cryptocurrency exchanged. As new transactions are created, the transactions go into a pool of pending transactions waiting to be verified by a node (known as a "miner"). Miners select a set of transactions (known as a "block") from the pool and compete to add the transactions to the blockchain.

The miners will validate the transaction message to determine that the request is authentic and that the sender's account holds a sufficient amount of cryptocurrency to satisfy the transfer. Every account number is associated with a 'private key' (only known to the account holder) and 'public key' available to all the nodes. The private key is used to create the 'digital signature' by encrypting the transaction message. The miners test the digital signature using the associated public key and try to decrypt it. If successfully decrypted, this proves that the digital signature was created by the true account holder.

Miners compete to solve a complex mathematical problem known as a 'hash function'. The hash function is extraordinarily special in that there is no trick to solving it faster, other than by increasing computing power. The first miner to solve the hash function gets to add their block of transactions to the end of the blockchain and all other miners update to this new version of the blockchain. The transaction is settled once it is added to the blockchain. Thereafter, a new hash function is created and the process repeats.

Miners incur great costs to build computers to solve the hash functions. The miners are incentivized to do this because every time a miner adds a new block of transactions to the blockchain, the miner is rewarded with a certain number of newly-issued cryptocurrencies.

What is an ICO?

Similar to an IPO, an ICO or initial token offering ("ITO") is a means by which fintech businesses raise funds for a new cryptocurrency venture. In an ICO or ITO, an investor exchanges fiat currency or another type of cryptocurrency for coins or tokens issued by the company. These coins or tokens can have different functions. For example, Impak released a new digital currency is to be used in the Impak's own platform, impak.eco. Investors then use the coins to participate in the impact economy, and donate to projects that have a positive impact on society.

Cryptocurrencies and CSA Staff Notice 46-307

The legislative scheme used by securities regulators in Canada is a 'catch-then-exclude' mechanism whereby a security is defined broadly to catch all transactions and then exemptions carve-out situations where regulation is not justified. Cryptocurrencies may be characterized as an 'investment contract' and thus may be caught within the definition of a security.

The CSA published the Staff Notice on August 24, 2017 addressing ICOs/ITOs. While there are technical differences between coins and tokens for the purposes of the Staff Notice, coins and tokens are treated similarly, as the analysis focused on the triggering of securities laws in Canada. The Staff Notice encouraged ICOs/ITOs but raised investor protection concerns due to issues around volatility, transparency and the potential for cryptocurrencies to be used in unethical practices or illegal schemes.

The Staff Notice states that ICOs/ITOs are similar to IPOs in many ways. The coins/tokens can be analogized to shares of a company because the value of a coin/token may increase or decrease depending on the success of the business conducting the ICO/ITO.

The Test

In determining whether or not an 'investment contract' exists, the Staff Notice advised that businesses should apply the following four-prong test from the decision of the Supreme Court of Canada in Pacific Coast Coin Exchange v. Ontario (Securities Commission)2 to determine whether the ICO/ITO involves:

  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 Staff Notice stated that, in many cases, when the totality of the offering or business is considered, cryptocurrencies should properly be considered securities. However, the Staff Notice stated that every ICO/ITO is unique and must be assessed on its own characteristics.

If a cryptocurrency offering is considered an offering of securities, the business conducting the offering will need to meet the prospectus, registration and/or market place requirements.

Prospectus

To date, no business has used a prospectus to complete an ICO/ITO in Canada. The CSA anticipates that businesses looking to sell cryptocurrencies may do so under prospectus exemptions such as the 'accredited investor' exemption or the 'offering memorandum' exemption.

The CSA is aware that some fintech businesses publish 'whitepapers' with respect to their ICOs/ITOs. Although whitepapers are a form of disclosure document for investors, they often do not meet the specific disclosure requirements to be properly considered a prospectus/offering memorandum. It is important to note that investors can sue for misrepresentation in the prospectus/offering memorandum and investors may have civil remedies against fintech businesses failing to comply with the securities laws.

Registration

Businesses completing ICOs/ITOs may be trading in securities for a business purpose (the "business trigger"), which would therefore require dealer registrations. Fintech businesses that meet the business trigger must meet certain obligations to investors, including the know-your-client requirement ("KYC") and the suitability requirement. These obligations may require businesses conducting ICOs/ITOs to collect information regarding an investor's identity, investment objectives and risk tolerance. The Staff Notice acknowledged that it is possible to fulfill the KYC and suitability obligations through an automated online process.

Marketplace

The exchanges upon which cryptocurrency can be bought and sold often operate without oversight or regulation, and can be found around the world. A cryptocurrency exchange that offers cryptocurrencies that are securities must determine whether it is a marketplace. If the exchange is doing business in a jurisdiction in Canada, it must apply to that jurisdiction's securities regulatory authority for recognition or an exemption from recognition.

The Staff Notice states that fintech businesses should seek legal and/or other professional advice to assess whether or not securities laws apply to avoid placing the ICO/ITO offside securities laws. For example, coins or tokens that constitute securities being used to trade on cryptocurrency exchanges could result in the issuer violating restrictions on secondary trading pursuant National Instrument 45-102 Resale of Securities.

Cryptocurrency Investment Funds

The CSA is also aware of 'investment funds' as defined under securities laws being set up to invest in cryptocurrencies. The Staff Notice encouraged fintech business looking to establish cryptocurrency investment funds to consider the following:

  1. prospectus requirements, as well as investment fund rules and the suitability of the investment,
  2. due diligence on any cryptocurrency exchange that the investment fund uses to purchase or sell cryptocurrencies, specifically looking at the policies and procedures around identity verification, anti-money laundering, counter-terrorist financing and recordkeeping,
  3. appropriate registration requirements,
  4. valuation methods used to value the cryptocurrencies in the investment fund's portfolio, and
  5. expertise of custodians holding portfolio assets to ensure expertise are relevant to holding cryptocurrencies.

With respect to the expertise of custodians, the CSA provided guidance in the form of a non-exhaustive list of items as to what expertise may be required of custodians dealing with cryptocurrency, including experience with hot and cold storage, experience with security measures to protect the cryptocurrency from theft, and the ability to segregate cryptocurrency from other holdings as needed.

CSA Sandbox

The recently launched CSA Sandbox is an initiative to support fintech businesses seeking to offer innovative products, services and applications in Canada. The CSA Sandbox allows businesses to register and/or obtain exemptive relief from securities requirements, under a faster and more streamlined process than through a standard application.

Conclusions from the Staff Notice

While acknowledging the emergency of a new mechanism for capital raising, the Staff Notice provided issuers of cryptocurrency with a warning that their activities may violate prospectus requirements, registration requirements, and the general disclosure requirements that were created to protect investors in capital markets. While regulation of cryptocurrency remains in its infancy, increased scrutiny of transactions involving the issuance of virtual coins or tokens is expected to ultimately bridge a regulatory scheme for such cryptocurrency in line with securities requirements.

The Impak ICO

McMillan recently acted for Impak in its CSA Sandbox application for exemptive relief with respect to Impak's ICO. Pursuant to its ICO, Impak proposes to issue a new digital currency (known as "MPK") to fund the development of an online social network by way of a private placement in reliance on the offering memorandum exemption.

In consultation with the other members of the CSA Sandbox, the AMF granted Impak exemptive relief from the dealer registration and prospectus requirements in connection with proposed MPK ICO. The AMF stated that, in the absence of a prospectus relief, the first trade of MPK will be a distribution.

The AMF granted the registration relief under the following conditions:

  • Impak will conduct KYC and suitability reviews and verify accredited investors,
  • Impak will not provide investment advice to investors,
  • Impak will deal fairly, honestly and in good faith with its investors, and
  • Impak will establish procedures to manage the risks associated with its business.

The AMF stated that the prospectus requirement will apply to a first trade in MPK, unless the first trade is made between an Impak user and an impact organization (i.e., businesses, non-governmental organizations, not-for-profit corporations and social enterprises) in either of the following cases:

  1. an Impak user pays in MPK for goods and services offered by an impact organization, or
  2. an impact organization rewards the Impak user for such purchase.

The AMF also imposed the following conditions:

  • Impak will make certain quarterly information reasonably available to participants,
  • MPK issued in the ICO will not be listed and traded on any exchange, and
  • Impak will provide the AMF with any report or information that may be requested.

In addition to the Provinces of Quebec and Ontario, and in reliance on Regulation 11-102 respecting Passport System, the AMF's decision is intended to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, New Brunswick, and Nova Scotia. The AMF's decision document has been published as of August 15, 2017, and can be under the following link: Impak Finance Inc.

Footnotes

[1] Securities Act, RSO 1990, c S.5, s 1.

[2] (1977), [1978] 2 SCR 112, 80 DLR (3d) 529.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2017

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions