As blockchain technology continues to develop, and its role in fundraising initiatives by technology companies increases, the Canadian Securities Administrators (the "CSA") have issued guidance on the application of securities laws to offerings of blockchain-based tokens ("Tokens"), including a subset of Tokens referred to as "utility tokens". In Staff Notice 46-308: Securities Law Implications for Offerings of Tokens (the "Staff Notice"), the CSA advise that an offering of Tokens (which may commonly be identified as "cryptocurrency" or "crypto tokens") will trigger the application of securities laws if it involves the distribution of a "security" under securities laws, based on a substantive, and not a formulaic analysis.
While a "security" is broadly defined in Canadian provincial securities laws and includes numerous examples, the example of an "investment contract” has received the most judicial treatment and is generally considered to be a residual category for investments that do not fit into boxes commonly thought of as securities, such as shares, options or bonds. The "investment contract" designation is particularly relevant to "utility tokens", as the CSA have found that most of the offerings of purported "utility tokens" they reviewed involved the distribution of an "investment contract". In order to assess whether a particular Token is an "investment contract", Token issuers should consider whether the following four indicia of an "investment contract" are present:
- an investment of money;
- in a common enterprise;
- with the expectation of profit; and
- to come significantly from the efforts of others.
When performing this assessment, the CSA are focussed on substance over form, and purposive interpretation. This means that the economic realities of the offering as a whole should be assessed, along with the technical characteristics of the Token being offered, all in the context of the investor protection objectives of securities law. For example, if there is an indication that an investor is purchasing a Token with the expectation that it could be traded on cryptoasset trading platforms, particularly where the existence of trading on secondary markets is critical to the success of the offering or is a prominent feature of the marketing of the offering, a key element of the definition of “investment contract” would be met. Although Token issuers do not necessarily have control over the trading of their Tokens on secondary markets, the CSA is of the view that this is generally not, on its own, relevant to the assessment. For further illustration of these principles, readers should refer to the Staff Notice, which provides numerous examples of the application of the "investment contract" assessment to various types of Token offerings.
Consistent with its focus on substance over form and the economic realities of Token offerings, the CSA also caution that the use of multi-step transactions in Token offerings to circumvent securities laws raise similar concerns. Generally speaking, multi-step transactions for Token offerings involve: (i) one or more purchasers agreeing to contribute money in exchange for a right to receive Tokens at a future date (commonly undertaken by a "simple agreement for future tokens" or "SAFT") pursuant to a prospectus exemption, such as the accredited investor exemption, and (ii) the delivery of the actual Tokens at such future date. While many issuers have taken the position that the delivery of the Tokens does not trigger the application of securities laws, the CSA instructs that further assessment, including the application of the factors discussed above, is required to make such a determination.
Overall, the Staff Notice contains welcomed guidance for those engaging in Token offerings and we anticipate further guidance will be issued as the burgeoning cryptocurrency industry continues to evolve. In the meantime, industry participants are cautioned to heed the CSAs’ current guidance, as the CSA are actively conducting surveillance of Token offerings to identify past, ongoing and potential future securities law violations.
To discuss the application of securities law to Token offerings or cryptocurrencies generally, please contact any member of our Corporate Finance and Securities Group.
A special thanks goes to summer student Sebastian Crema for his assistance with the preparation of this blog post.
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