How Securities Law Applies to Offerings of Blockchain-Based Tokens and Coins: More Examples and CSA Comments
June 12, 2018
On June 11, 2018, the Canadian Securities Administrators (CSA) published Staff Notice 46-308 Securities Law Implications for Offerings of Tokens (Staff Notice), which provides additional guidance on the applicability of securities law to offerings of blockchain-based tokens or coins.
The Staff Notice builds on the CSA’s August 2017 Staff Notice 46-307 Cryptocurrency Offerings, which had provided initial guidance but only limited examples. The new Staff Notice outlines examples of specific situations derived from previous situations or inquiries.
Echoing recent comments of the Chair of the US SEC, the CSA’s news release announcing the Staff Notice quoted CSA Chair Louis Morisset as saying, “Since publishing initial guidance, we have engaged with numerous businesses considering token offerings and have found that most of these offerings involve securities”.
The Staff Notice reiterates the Canadian case law interpreting the term “investment contract”. It goes on to provide guidance on how the staff have viewed certain examples, based on situations seen to date. With respect to utility tokens, the Staff Notice notes in particular that, “the fact that a token has a utility is not, on its own, determinative as to whether an offering involves the distribution of a security.”
In this regard, the Staff Notice is careful to leave exceptionally wide interpretive flexibility to the CSA. In particular, the Staff Notice notes that an offering of tokens may involve the distribution of securities because it is an investment contract or the tokens issued are securities under one or more of the other enumerated categories of the statutory definition of securities. The Staff Notice goes further to say it “may be a security that is not covered by the non-exclusive list of enumerated categories of securities”.
Under the statutory definition, a security “includes” the enumerated list of categories, one of which is an investment contract. The word “includes” leaves open the possibility that even if an item distributed is determined not to be an investment contract nor any of the other types of categories listed in the definition of a security, the staff (or a court) might still determine that the item distributed nevertheless constituted a security.
Similarly, in introducing their table of interpretive examples, the Staff Notice states cautiously: “It is possible that an offering of tokens may be viewed as involving, or not involving, a security even with the existence, or absence, of one or more of the characteristics listed below,” which while true, doesn’t provide much regulatory certainty.
SITUATIONAL INTERPRETIVE EXAMPLES
The principal value of the Staff Notice lies in 14 examples of situations involving the issuance of tokens, accompanied by the staff’s discussion of possible implications under securities law for each, which is helpful in ascertaining staff’s views on the application of certain elements. While the examples do not provide staff’s full legal analysis of each situation under all four elements of the Howey test, most examples focus on one or two of those elements. Here are some examples with potentially broad application:
If an issuer’s management retains for themselves a significant number of unsold tokens from the offering, or pre-mines them as a form of compensation for their efforts, staff’s view is that this could indicate the existence of a common enterprise, since the future increase in value would financially benefit both management and investor.
There are a number of staff comments around free tokens, given current predilections for “airdrops”. If free tokens are offered as a bounty to persons who promote the offering through social media, staff’s view is that these persons may have an incentive to promote the offering as an investment, creating an expectation of profit. On the other hand, tokens that are distributed to users for free “will likely not involve an investment of money.” However, staff goes on to say that if the distribution of free tokens is part of an overall sale of an ancillary product or service, that may involve an investment of money.
Management statements suggesting that the tokens will appreciate in value, or encouraging others to make, or even acquiescing in the making of such statements, could create an expectation of profit, in staff’s view. They contrast this with situations where, if management “clearly and uniformly promotes the token in a manner that, taken as a whole, promotes only its utility and not its investment value, the implication that purchasers have an expectation of profit may be reduced.”
TOKEN TRADING PLATFORMS
Another situation is with respect to trading of tokens through trading platforms, whether decentralized or peer-to-peer, or making otherwise freely tradable in secondary market. Staff’s view is that this fact “indicates that purchasers may purchase the tokens with an expectation to resell them at a profit.” The Staff Notice addresses trading of tokens through trading platforms from the point of view of whether this is more likely to characterize the tokens as a security. In their June 6, 2018 CSA Investor Alert: Caution Urged for Canadians Investing With Crypto-Asset Trading Platforms, the CSA cautioned that currently, there are no crypto-asset trading platforms recognized as an exchange or otherwise authorized to operate as a marketplace or dealer in Canada.
SAFT AND OTHER MULTI-STEP OFFERINGS
CSA staff stated their views on offerings of tokens structured in multiple steps, where the first step involves the purchase of a right to receive tokens at a future date, pursuant to a SAFT (simple agreement for future tokens) or similar agreement. Staff reminded issuers that securities distributed under capital-raising prospectus exemptions are typically subject to resale restrictions, which may continue for an indefinite period. They confirmed their view that a token delivered in the later step may still be a security despite the fact that the token may have some utility, because it either has a number of the securities factors identified or has other security-like attributes. The staff said: “We will have concerns where a multiple step transaction is used in an attempt to avoid securities legislation… businesses and their professional advisors should assess the economic realities of the offering as a whole, with a focus on substance over form.”
Finally, the Staff Notice includes a reminder about the CSA regulatory sandbox, where firms are encouraged to obtain exemptive relief from securities law requirements in order to test their products, services and applications in Canada. This has seen only limited use: there have been two token distributions with partial exemptions provided to date.
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