Canada: Keeping Up With Crypto Asset Anti-Touting Laws – A Reminder From Kim Kardashian

For a mega-celebrity like Kim Kardashian, who endorses everything from "flat tummy" lollipops to laser hair removal systems, making a plug for a crypto token on her Instagram account may have been business as usual.

The U.S. Securities and Exchange Commission ("SEC"), however, had a different view that led to Kardashian reportedly paying US$1.26 million in penalties, disgorgement and pre-judgment interest in September. According to the SEC's press release of October 3, 2022, Kardashian was paid US$250,000 to promote crypto tokens offered and sold by EthereumMax ("Emax") to her 250 million followers on Instagram in June last year. The promotional post included a link to the Emax website that had instructions for investors to purchase Emax tokens. Kardashian did not disclose being paid for the promotion, which is a violation of Section 17(b) of the U.S. federal Securities Act of 1933. That section makes it unlawful for any person to tout a security without disclosing the amount received or to be received (or other benefit) from an issuer, underwriter or dealer, whether directly or indirectly. The reality TV star agreed to co-operate with the SEC investigation and not to promote crypto securities for three years.

Kardashian is not a complete illiterate in the law, having passed the "baby bar" in California last year. One would also presume that celebrities and influencers get legal advice before posting anything on social media that has legal consequences. So, what is it about securities laws governing promotion of crypto assets that makes them a legal "black box"?

Enforcement of U.S. Anti-Touting Laws

The SEC's guidance has been categorical since November 2017, when it first issued a statement around celebrity-backed Initial Coin Offerings ("ICOs"), calling the failure to disclose the required information a violation of anti-touting provisions of the federal securities laws. Participating in an unregistered offer and sale of securities, or acting as an unregistered broker, can also potentially invite anti-fraud provisions.

The Kardashian case is the latest in a series of enforcement actions by the SEC that has seen other celebrities like DJ Khaled, Floyd Mayweather and Steven Seagal meeting with similar consequences for similar offences. In October 2020, the SEC charged the founder of anti-virus software McAfee, John McAfee, for promoting ICOs to his Twitter followers without disclosing that he was paid more than US$23 million in digital assets for doing so. In July 2021, the SEC charged the U.K.-based operator of www.coinschedule.com approximately US$197,000 for failing to disclose the compensation it received from issuers of digital asset securities that it profiled on its website.

The SEC's Framework for "Investment Contract" Analysis of Digital Assets of April 2019 ("Framework") attempted to clarify if a digital asset will qualify as an investment contract (which is one kind of security). The Framework reiterated the law laid down by the U.S. Supreme Court in SEC v. W. J. Howey Co., 328 U.S. 293 (1946) that an investment contract means a contract, transaction or scheme whereby a person invests money in a common enterprise and is led to expect profits solely from the efforts of others, irrespective of whether it has the characteristics of typical securities. The onus of analyzing the relevant transactions to determine if federal securities laws apply is on the issuers and others who market, offer, sell, resell or distribute digital assets.

As recently as April of this year, SEC Chair Gary Gensler said in a speech that crypto-trading platforms play roles similar to those of traditional regulated exchanges and, consequently, merit registration and regulation. He added that most, if not all, crypto tokens are investment contracts under the Howey test. Nothing surprising, considering the SEC, in the recent past, has penalized perpetrators of pyramid schemes making false promises of cryptocurrency riches to investors, fraudulent cryptocurrency trading funds, unregistered offers and sales of crypto-lending products, and fraudulent cryptomining schemes.

What if Kardashian Looked to the 'True North'?

Canada does not have a federal securities regulator such as the SEC in the U.S., thanks to the Canadian Constitution assigning jurisdiction over property and civil rights to the provinces. However, Canada does have the Canadian Securities Administrators ("CSA"), a collaboration of 10 provincial and three territorial securities regulators, that is chiefly responsible for fostering a harmonized approach to securities regulation across the country. Canada also has the Investment Industry Regulatory Organization of Canada ("IIROC"), a self-regulatory organization overseen by the CSA, that regulates investment dealers and trading activities of equity and debt marketplaces.

Now, let's assume for a moment that Kardashian's Instagram post meets the "real and substantial connection" test to attract securities regulations in British Columbia and Ontario, the two Canadian provinces that are among the largest contributors to the country's GDP.

In November 2018, the CSA published CSA Staff Notice 51-356 Problematic promotional activities by issuers to illustrate specific problems in promotional activities by issuers that provide "unbalanced or unsubstantiated material claims about the issuer's business." Among the activities of concern listed in the Notice is "compensating third parties, who use social media and general investing blogs to promote issuers, but do not disclose their agency, compensation and/or financial interest." (Remind you of anyone?) The Notice makes it clear that non-compliance could result in enforcement action or regulatory responses requiring the issuer to publish a news release; retract or remove overly promotional language from their disclosure record (including their website and/or social media); and/or re-file continuous disclosure statements.

British Columbia

British Columbia amended its Securities Act ("the Act"), effective March 2020, to provide the British Columbia Securities Commission ("BCSC") with more tools to address problematic promotional activity. One of the amendments introduced new prohibitions in section 50(3) of the Act on making false or misleading statements, including omitting a fact necessary to make such statements not false or misleading, when engaging in promotional activities, if a reasonable investor would consider them important in making investment decisions.

Around the same time as Kardashian settled with the SEC, the BCSC ordered a British Columbia mining company and a reporting issuer in the province, MGX Minerals Inc. and its CEO, to pay a total of C$35,000 in settlement for failing to disclose that promotional advertorials and social media posts were issued on the company's behalf. The BCSC's news release of September 20 states that multiple promotional posts were made by 17 social media influencers on platforms such as Twitter, Facebook and LinkedIn. All were made to appear as objective journalistic content. Some of the posts indicated a fee was paid but did not identify the payer or the payee. MGX Minerals Inc. had partnered with a marketing company to conduct investor relations activities.

Given these laws and precedents, Kardashian would certainly run into trouble with the BCSC for the same reasons she did with the SEC.

Ontario

The final report of the Capital Markets Modernization Taskforce ("Taskforce") recommends creating a new and specific prohibition on making misleading or untrue statements about public companies (policy recommendation 74). The Taskforce was formed by the Ontario government in 2020 to review and modernize the province's capital markets regulatory framework. The prohibition will allow the Ontario Securities Commission ("OSC") to enforce action against any person or entity making statements that could "influence the investment decision-making of a reasonable investor." Importantly, the report recommends that the OSC would not need to prove the causal link between market distortion and the statements. A mere intent to "impact the market or influence a reasonable investor's decision-making would be sufficient."

Once the Taskforce's recommendations become law, Kardashian could possibly face the music from the OSC as well.

A Reminder to Issuers in Canada

It is never a wrong time for issuers – whether private or public companies – to remind themselves of the policy and legislative underpinnings of anti-touting provisions and securities laws in general in Canada that have, in many respects, been modelled after U.S. laws over the years. The Supreme Court of Canada, in Pacific Coast Coin Exchange v. Ontario Securities Commission, [1978] 2 S.C.R. 112, adopted the Howey test to determine if an instrument constitutes an investment contract. Importantly, the court observed, the Securities Act (Ontario) does not exclusively aim at schemes that are actually fraudulent, but at arrangements that do not allow the customers to know exactly the value of the investment they are making. The word "solely" in the Howey test ("an investment of money in a common enterprise, with profits to come solely from the efforts of others") has been watered down in many jurisdictions in the U.S.

The Pacific Coast judgment also urges securities regulators to consider economic realities and the policy objective of investor protection in construing the Securities Act (Ontario). Substance, not form, governs the determination of an investment contract. The CSA has expressly toed this line in its Staff Notices since 2017 (Staff Notice 46-307 and 46-308).

What this means for social media influencers like Kim Kardashian, whose recommendations cross international boundaries, is that they must take care not to offend securities laws in jurisdictions where their recommendations may have an impact.