Andrew Burke, David Randell and Divya Subramanian

There is never a dull moment when it comes to cryptocurrency: whether it is the hacking of a South Korean crypto exchange, the U.S. Securities and Exchange Commission announcement that Ether is not a security or the ongoing issues on the new EOS blockchain, if you are attempting to keep up with crypto, don’t blink – you will miss something.

Not to be lost in all the activity is what is happening here in Canada, in particular as it relates to the Canadian Securities Administrators (“CSA”) and proposed amendments to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (the “Act”).

CSA staff notice 46-308 securities law implications for offerings of tokens

On June 11, 2018, CSA published its second staff notice on cryptocurrency offerings. The Staff Notice 46-308 Securities Law Implications for Offerings of Tokens (“SN 46-308”), is a follow up to the earlier Staff Notice 46-307 Cryptocurrency Offerings (“SN 46-307”) issued in August 2017, which provided initial guidance on the applicability of securities laws to token offerings. Our update on SN 46-307 can be found here.

SN 46-308 focuses in particular on “utility tokens” and provides some insight into the different token offerings that the CSA has encountered. The highlights of SN 46-308 are set out below, but the message from the CSA is clear – when it comes to token offerings, substance matters more than form, and the CSA is monitoring activity in the space carefully as it relates to compliance with securities laws.

(i) Utility tokens – a security?

The CSA has been consistent with its message that it invites businesses considering token offerings to reach out and discuss the application of securities laws to their proposed offering. SN 46-308 makes it clear that many of the submissions received by the CSA have suggested that due to the “utility” nature of the proposed token (e.g. utility in software, use in the purchase of goods or services, etc.) that the application of securities laws would be limited – a view which the CSA does not seem to share. SN 46-308 states that despite the utility nature of a token, in many cases the proposed offering did involve a security and “the fact that a token has utility is not, on its own, determinative as to whether an offering involves the distribution of a security”.

SN 46-308 states that businesses and professional advisors must consider the “investment contract” test when analyzing security implications to an offering, and should consider “not only the technical characteristics of the token itself, but the economic realities of the offering as a whole, with a focus on substance over form.”

SN 46-308 goes on to provide a helpful list of token/offering features that would have an implication on the presence of one or more elements of an investment contract. SN 46-308 goes on to provide a helpful list of token/offering features that would have an implication on the presence of one or more elements of an investment contract including, among others:

• Software/application/online platforms with proposed functions, but the software/application/platform is unavailable or in development at the time of the offering;
• Delayed delivery of tokens to purchasers;
• Bounty and loyalty programs;
• Retention of tokens by issuer as compensation for its efforts;
• Representations that the management of the issuer possess skills that are likely to increase the value of the token;
• Finite number of tokens issued or reasonable expectation that access to tokens is limited;
• Statements by the issuer projecting likely appreciation in value; and
• Marketing the offering to persons who are not reasonably expected to use the issuer’s product, service or application.

Of particular relevance to the CSA when considering the elements of an investment contract is the presence, or expected presence, of the token on a cryptoasset trading platform. The presence of a token on a trading platform or exchange is not necessarily within the control of the issuer of the token. In fact, control (or lack thereof) that an issuer may have over the secondary trading of their token is not necessarily relevant to the analysis. To decipher whether there is a reasonable expectation that the token will be traded in secondary markets, the CSA may look at formal representations in the white paper and/or informal social media posts relating to the offering as well as third party representations that are explicitly or implicitly endorsed by the issuer or its management.

(ii) Multiple step token offerings and enforcement

SN 46-308 also discusses offering structures where tokens are not delivered in the first instance (e.g. through the use of a simple agreement for future tokens). The CSA makes clear that it is monitoring multi-step transactions to ensure businesses and issuers are not using these structures as a means to circumvent securities legislation.

The CSA expressly states that it is conducting active surveillance to identify past, ongoing and future securities laws violations and conduct – a sizable undertaking. Of particular interest is the statement that regulatory authorities “may have jurisdiction over trades to investors outside of that jurisdiction where there is a real and substantial connection between the transaction and that jurisdiction”. This is a clear warning to residents of Canada involved in cryptoassets or contemplating a venture into crypto that simply taking steps to ensure tokens are not available to Canadians when being distributed does not necessarily mean that the CSA does not have jurisdiction.

Amendments to anti-money laundering regulations

The Act governs the regime against money laundering. The proposed amendments to the regulations under the Act are, in part, based on the evolving transactions using digital currencies. The draft regulations were released on June 9, 2018 and are open for comment until September 7, 2018.

The proposed amendments define a “virtual currency” to mean:

(a) a digital currency that is not a fiat currency and that can be readily exchanged for funds or for another virtual currency that can be readily exchanged for funds; or

(b) information that enables a person or entity to have access to a digital currency referred to in paragraph (a).

As a result of the amendments to the regulations, those “dealing in virtual currency” (e.g. virtual currency exchange services and value transfer services) would be regarded as a Money Service Business (“MSB”) thereby requiring such entities to implement a full compliance program, including the implementation of audit procedures and the appointment of a chief anti-money laundering officer, as well as to register with Financial Transactions and Reports Analysis Centre of Canada (“FINTRAC”).

The Government has recognized that globally accessible virtual currencies allow for transfer of funds devoid of any borders and intermediary institutions. As a result, these transactions by-pass traditional barriers that govern the financial sector and without proper regulations provide opportunities for fraudulent transactions, identity theft and other dangerous forms of cybercrime.

The foregoing is intended to provide a brief overview of SN 46-308 and proposed amendments to the regulations of the Proceeds of Crime (Money Laundering) and Terrorist Financing Act and is intended for general information only. If you have any questions, or for more information, please contact Andrew Burke, David Randell or Divya Subramanian