In August 2017, we considered the guidance offered by the Canadian Securities Administrators (CSA) regarding the application of securities laws to the blockchain industry and initial coin offerings (ICOs), primarily as set out in CSA Staff Notice 46-307 Cryptocurrency Offerings. In that post, we noted that the CSA have provided little guidance regarding when they would consider cryptocurrencies to be securities, and thus subject to Canadian securities rules.
Since then, the industry has continued to develop and regulators, both in Canada and the United States, have been steadily increasing efforts to stay abreast of and address the emerging legal issues in this space.
To date, much of the regulatory developments in the blockchain and cryptocurrency industry have been led by the United States Securities and Exchange Commission (SEC). However, given the similarities in securities law and industry between the Canadian and US markets, we believe it is worth noting what actions the SEC has taken recently.
In December 2017, SEC Chairman Jay Clayton issued a statement regarding his concerns with ICOs and the unregulated state of the cryptocurrency market. He warned that while ICOs may be an effective means of raising capital, issuers and their advisors should remember that the substance of the transaction will override its form, and therefore, if a coin or token is fundamentally a security, no matter how the transaction is structured, the required disclosures and investor protections should be provided, or the appropriate exemption relied upon. In all cases, the spirit and purpose of securities laws will be central to determining whether or not an instrument is a security.
In the weeks that followed Clayton’s statement, the SEC sought and obtained a halt order for an allegedly fraudulent ICO by Dallas-based AriseBank and its founders, and also began issuing subpoenas and demands for information to dozens of cryptocurrency firms and advisors. Included in the mass inquiry were those involved in issuing “simple agreements for future tokens,” or SAFTs.
SAFTs are intended to function in much the same way as “simple agreements for future equity,” or SAFEs, in that an investor would invest in an early stage company pursuant to the SAFT and receive in exchange the right to obtain something of value in the future; in this case, a utility token. The US-based SAFT Project, a forum focused on regulatory compliance as it relates to token sales, contends that while a SAFT would likely be a security, the utility tokens issued by the company pursuant to the SAFT would not be securities. Despite this characterization, given the SEC’s stated position with respect to cryptocurrencies and its recent enforcement actions, those transacting with SAFTs and other novel instruments are well-advised to rigorously consider at what point or points they may be issuing securities.
In Canada, the British Columbia Securities Commission recently issued a notice and request for comment: BC Notice 2018/01 Consulting on the Securities Law Framework for Fintech Regulation. The notice identified certain risks associated with ICOs and the cryptocurrency market, including cyber security, price volatility, potential illiquidity, and money laundering. In addition, the notice raises questions around the operations of cryptocurrency investment funds and fund managers, custody requirements in connection with digital assets, know-your-client obligations, and the distinguishing factors between a utility token and a security. Industry members are being asked to provide comments on the notice by April 3, 2018.
Most recently, the Canadian Securities Exchange announced its plans to institute a blockchain platform for clearing and settling securities, which would allow trades to be confirmed instantly. Rival TMX Group Inc. also broadcast in a press release issued on October 17, 2017 its intention to automate the settlement process using blockchain technology. With the potential advent of these blockchain-driven clearing houses, perhaps there is more of an appetite in Canada for the creation of new ecosystems and exchange rules tailored to the blockchain industry.
It is clear that regulators are paying attention and heightening scrutiny in the blockchain and cryptocurrency industry. Whereas in early 2017 industry participants operated with little regulatory oversight, the past several months have seen an increased effort by lawmakers to zero in on the regulatory issues posed by the emerging space. This presents an opportunity for market participants to help shape the regulatory framework within which they may operate in the future, as we believe that regulators will seek to work with companies that prioritize matters like investor protection and generally bring trustworthiness to the market. We continue to encourage issuers and other stakeholders to consult with their advisors on these evolving issues.