Canada: Read This Before Your ICO: Minimizing The Risk Of A Securities Token

Summary

On December 11, 2017, the U.S. Securities and Exchange Commission (SEC) issued a cease-and-desist order against Munchee Inc. ("Munchee") to stop Munchee's Initial Coin Offering (ICO) and require it to return to investors the funds it collected through the sale of its MUN token (the "Munchee Order"), which the SEC deemed to be securities. See the discussion in our December 18 Update, ICO Wars: The SEC Strikes Back.

The Munchee Order provides insight into some of the token issuer activities the SEC will consider in determining whether tokens issued during ICOs are securities. The SEC employs a four-part test – the Howey Test – to determine whether a financial instrument or investment contract is a security. In the context of tokens, the crucial elements of this test are whether the tokens represent "an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others".1 In Canada, a similar test is set out in the Supreme Court of Canada's decision in Pacific Coast Coin Exchange v. Ontario (Securities Commission).

Drawing from the Munchee Order, and other decisions and commentary by regulators and academics, we have compiled some strategies for token issuers to help mitigate the risk of regulators deeming their tokens to be securities. The following review will focus on the two more contentious prongs of the Howey Test, being whether: (i) the token issuer provided investors with a reasonable expectation of profit; and (ii) those profits are expected to be derived from the efforts of others.

While avoiding the pitfalls outlined below may decrease the risk of having a token deemed a security, there are no guarantees. Regulators have so far chosen to approach ICOs on a case-by-case basis and have indicated each token must be considered in the context of its particular circumstances.

ICO: What NOT to do

The following token issuer activities may suggest to regulators an issuer's token is a security. Token issuers should avoid:

Providing purchasers with a reasonable expectation of profit

  • Posting material online that suggests investors will profit. Munchee made statements in its White Paper, on blogs, podcasts, and Facebook posts that suggested investors would profit from purchasing MUN tokens. For instance, Munchee (i) published a blog post entitled "7 Reasons You Need To Join the Munchee Token Generation Event" which provided that "As more users get on the platform, the more valuable your MUN tokens become." The Canadian Securities Administrators (CSA) have also suggested that attending public events, including conferences and meetups, to actively advertise the sale of your token could indicate your token is a security. For more on the CSA's current position on ICOs, see our August 30 Update, Initial Coin Offerings in Canada: The CSA Weights In.
  • Endorsing third-party posts that suggest investors will profit. Munchee endorsed other commentators' public statements that touted the opportunity for profit through the purchase of MUN tokens. For example, Munchee created a public post on Facebook with the caption: "199% GAINS on MUN token at ICO price!" and linked the post to a YouTube video in which the person featured claimed if investors got in early enough on ICOs, they would make a profit.
  • Not soliciting existing stakeholders. Munchee, which had a functioning restaurant review app in which users would ultimately use MUN tokens, did not specifically target current users of the Munchee App or stakeholders in the restaurant industry. Instead, Munchee targeted forums for people more generally interested in investing in cryptocurrencies.
  • Promoting a secondary market. Munchee highlighted in its White Paper that a secondary market for MUN tokens would be available shortly after the completion of the offering.
  • Providing a deep discount on token pre-sale pricing. Though not addressed in the Munchee Order, commentators have suggested that offering early adoption discounts during an ICO or its pre-sale may be considered by regulators to encourage speculative investment and enhance investors' expectations of profit.

Providing purchasers with a reasonable expectation they will profit from the efforts of others

  • Emphasizing the importance of founders and management in creating value. Munchee highlighted the credentials, abilities and management skills of its agents and employees, suggesting investors would profit from their efforts in building the Munchee marketplace.
  • Not having a developed marketplace. Munchee provided in its White Paper that the value of the MUN tokens would depend on Munchee's ability to create an effective "ecosystem" for its restaurant review app, suggesting the Munchee team would continue substantial work on its marketplace after the ICO.

Relying on the SAFT

Token issuers should not assume they are securities law compliant simply because they used a Simple Agreement For Future Tokens (SAFT) framework in connection with their ICO. The SAFT framework aims to separate fundraising for an ICO into two stages: (i) before the development of the token marketplace, the issuer raises money by selling rights to future tokens to accredited investors; and (ii) once the token marketplace is developed, the issuer distributes the tokens to the investors. Proponents of the SAFT believe that at the time the tokens are issued to investors, the tokens have inherent utility such that they are not securities and can be sold on exchanges to non-accredited investors. The SAFT framework was discussed in our December 6 Update, Read this Before Your ICO: Exploring the SAFT Framework for Compliant Token Sales in Canada.

In the Munchee Order, the SEC suggested a method like the SAFT framework, which relied on a token no longer being deemed a security once it had utility, may not be effective. Specifically, the SEC stated "even if MUN tokens had a practical use at the time of the offering, it would not preclude the token from being a security. Determining whether a transaction involves a security does not turn on labelling – such as characterizing an ICO as involving a 'utility token', but instead requires an assessment of the economic realities underlying a transaction."

ICO: Best Practices

Geo-blocking ICOs

Issuers hoping to reduce the chance they will be subject to the review of regulators in certain jurisdictions may want to exclude investors in those jurisdictions by way of geo-blocking. Geo-blocking is a form of technological protection measure where access to Internet content is restricted based upon the user's geographical location. Geo-blocking can be circumvented (e.g., through use of virtual private networks) but even an attempt at geo-blocking could factor in favour of the issuer if regulators in a geo-blocked jurisdiction were to consider whether to take action against an issuer.

Sell tokens using existing securities exemptions

Issuers who are concerned about suffering the same fate as Munchee may choose to delay distributing tokens to the general public until regulators provide clearer guidance on when tokens will or will not be deemed securities (or issue new regulations aimed specifically at cryptocurrencies). In the meantime, issuers eager to raise funds for their new projects could do so now by selling tokens (or future tokens) through existing securities law exemptions, such as selling to accredited investors or utilizing the offering memorandum exemption, or by seeking specific exemptive relief to facilitate the offering through programs like the Ontario Securities Commission's LaunchPad initiative.

For further information on ICO compliance with securities laws, or guidance on the cryptocurrency regulatory environment and risk management, please contact any member of our Securities Law Group or Technology Group.

Goodmans Tech Group

To assist clients in the technology sector, Goodmans brings together our acknowledged expertise in corporate/commercial, private equity, corporate finance, mergers and acquisitions, outsourcing, licensing, intellectual property, privacy, regulatory and media, cleantech, tax, litigation, human resources, corporate restructuring and administrative law. We do so both for innovative businesses in their start-up phase and for well-established businesses of all types. Goodmans continues to lead in the technology sector and is partnered with the DMZ at Ryerson University. The DMZ is a leading business incubator (selected by UBI as the top-ranked university incubator in North America, and third in the world), which connects its start-ups with resources, customers, advisors, investors, and other entrepreneurs. Goodmans is also a proud partner of IDEABoost, an initiative of the Canadian Film Centre's Media Lab; building the next generation of technology-based media entertainment products, services and brands. Through these partnerships, Goodmans provides legal advice, mentorship and networking opportunities to assist startups in maximizing their potential.

Goodmans is also an internationally recognized leader in other aspects of technology law and transactions. From our thought-leadership, through participation on the Boards of associations such as CanTech (Canadian Technology Law Association), CORE (Centre for Outsourcing Research and Education), CIEG (Canadian Institute for Exponential Growth, which organized the Summit) and iTechLaw (International Technology Law Association), to our involvement in major technology procurement, joint venture and outsourcing transactions, to our representation, in court proceedings and in arbitrations, of major technology providers, and users of technology, in ground-breaking cases, our Technology Group is consistently at the forefront of leading technology transactions and cases.

Members of our Technology Group are recognized as leading technology lawyers in Chambers Global, Lexpert, Legal 500 Canada, Legal Media Group's The Best of the Best, The Best Lawyers in Canada, Law Business Research's The International Who's Who of Business Lawyers, and The Lexpert /American Lawyer Guide to the Leading 500 Lawyers in Canada, teach internet and communications law at Canada's largest law schools, are regular lecturers at technology industry events and legal conferences, and have published articles in the technology law field.

Footnote

1 United Housing Foundation, Inc. v. Forman, 421 U.S. 837 (1975).

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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
 
In association with
Related Topics
 
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