Regulators extend reach to bitcoin

The legal status of offerings of bitcoin and other cryptocurrencies in Canada has gotten a little clearer.

Of course, when it comes to law, “clear” is a relative term. Canadian regulators have not rolled out a brightline test that will instantly reveal when any particular initial coin offering (ICO) or initial token offering (ITO) would fall under a province’s securities laws.

But Canadian Securities Administrators, an umbrella group that co-ordinates policy among the country’s various provincial and territorial market regulators, has put out a road map that will shed at least some light on the issue.

Lawyers Geoffrey Rawle and Zain Rizvi of Davies Ward Phillips and Vineberg describe the CSA’s notice as “the strongest guidance to date on how securities regulators will view and regulate cryptocurrency offerings.”

The Ontario Securities Commission last March released a brief cautionary statement about blockchain or “distributed ledger technologies.”

The CSA notice, published last month everywhere except Saskatchewan, goes further. It adds guidance on how regulators will determine if an offering crosses into the realm of securities law. It also adds some examples: offering coins or tokens that operate a video game likely won’t trigger securities law; offering coins or tokens that are tied to future profits or business success likely will.

In short, you can expect Canadian regulators to have jurisdiction over cryptocurrency offerings in a lot of cases.

“In many cases, when the totality of the offering or arrangement is considered, the coins/tokens should properly be considered securities,” the CSA notice states. “In assessing whether or not securities laws apply, we will consider substance over form.”

The CSA’s notice is timely. Waterloo, Ont.-based Kik Interactive Inc. banned Canadians from participating in the initial public offering of its new cryptocoin. The company said it just wasn’t sure whether Ontario’s securities laws applied to its token offering.

In the CSA’s approach, the key question is whether an ICO or an ITO offering meets the definition of “investment contract.”

Back in the 1970s, the Supreme Court of Canada dealt with what constitutes an investment contract in a case called Pacific Coast Coin Exchange v. Ontario Securities Commission.

Pacific advertised in newspapers that it was selling bags of silver coins. Buyers sent in their orders by mail. Most of the company’s business was done on margin, with customers making deposits that covered 35 per cent of the purchase price. This gave Pacific a pool of money to finance its operations.

Delivery of the silver coins was not to take place until buyers paid the full purchase price. That didn’t happen very often. More than 85 per cent of Pacific’s customers never actually took delivery of the coins. Instead, they tended to wait for a while, then close out their margin accounts.

After paying commissions and interest, customers received or were paid the difference between their purchase price and the market price at closing.

The Supreme Court of The Canadian Securities Administrators group has set out some rules as to how bitcoins, above, and other cryptocurrencies will be regulated under provincial securities law, both for business in Canada or involving Canadian citizens. Canada found that Pacific was indeed selling investment contracts, and therefore subject to Ontario securities law. The court did so by adopting a four-prong test set out in 1975 U.S. case called SEC v. W.J. Howey Co.

The CSA notice takes that decades-old legal test and teleports it into the 21st century world of cryptocurrency. And here it is. ICO and ITO offerings are investment contracts if they involve (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.

Then there’s the geographic question. The CSA note says Canadian securities laws will apply if the sale involves business conducted within Canada or if there are Canadian investors.

This suggests a broad reach, note lawyers Rawle and Rizvi. “Interestingly, this statement suggests that ICOs by Canadian businesses that have incorporated in other jurisdictions or excluded Canadian purchasers from participating but operate in Canada could nevertheless be subject to Canadian securities laws.”

If an ICO or ITO falls within the scope of securities law, the promoters of the coin or token will need either to file a prospectus with regulators or have an exemption from the prospectus requirement.

And while some cryptocurrency backers publish “white papers” that describe their coins or tokens, these may not fully comply with securities law.

“Although white papers are a form of disclosure document for investors, it is important to note that they are often not structured in the same way as prospectuses or (offering memorandums). Investors must be provided with a document that complies with the requirements of securities laws,” the CSA says.

The CSA notice also discusses both cryptocurrency exchanges and investment funds.

The exchanges raise several questions, such as whether provincial securities regulators recognize them as marketplaces. Cryptocurrency investment funds, meanwhile, need to determine whether they is subject to Canadian securities laws, and if they are, ensure that its portfolio holdings comply with the appropriate laws.

“The CSA notice itself serves as a warning to the ecosystem of blockchain technology business — buyers, sellers, creators, exchanges and traders — that the days of unqualified, non-exempt ICOs for all cryptocurrency technologies are over,” the Davies Ward lawyers conclude.