Ontario Securities Commission’s Takes Its First Crack at Regulating a Token Generation Event

Many of you may recall that in March 2017 the Ontario Securities Commission (“OSC”), on the coat tales of its American counterpart, released “Staff Notice 46-307 – Cryptocurrency Offerings” (the “Notice”). We discussed the possible effect of the Notice in a previous blog posting “In the Matter of Token Funder Inc.” decision released last month by the OSC is its first decision with respect to a voluntarily submitted token generation event (“TGE”), confirmed our suspicions that, despite politically drafted purple prose that ostensibly encourages innovation, the “fast-tracked” Regulatory Sandbox TGE securities process is in effect only a deferral process which seeks to encourage self-reporting on the presumption that TGEs are public offerings of securities under the securities laws and regulations.

Pursuant to “National Policy 11-203 – Process for Exemptive Relief Applications in Multiple Jurisdictions” (“NP 11-203”), the OSC granted exemptive relief from the dealer registration requirement in order to allow it to launch a TGE under the offering memorandum prospectus exemption. The exemptive relief granted by the OSC was, however, based on a number of important restrictions, most notably that the filer agree to apply to become a registrant following the TGE. The filer will also not be able to launch the platform prior to becoming a registrant, is required to conduct “Know Your Client” investigations and suitability review for each token purchaser with the rebuttable presumption that none of the participants will qualify as “eligible investors” or “accredited investors”, and is required to provide full and complete disclosure to prospective token buyers.

The filer in this case “was established for the purposes of creating a platform, known as the smart token asset management platform” in order to “facilitate third-party issuers raising capital through the offering of blockchain-based securities, including tokens and coins.” The platform also intended to provide token and coin management and governance services for issuers. The purpose of TGE was to fund the completion of the platform and to facilitate transfers of digital tokens pursuant to available prospectus exemptions.

In coming to its decision, the OSC relied on certain representations made by the filer; such as:

  • The filer is not in default of securities legislation in any jurisdiction of Canada, and will not be in default of securities legislation as a result of the TGE.
  • The filer will conduct know-your-client and a suitability review for each person buying tokens, and each buyer will be required to undergo a comprehensive onboarding process, which will include the collection of information such as its investment needs and objectives, financial circumstances and risk tolerance.
  • The TGE will be made pursuant to the offering memorandum prospectus exemption. A maximum amount of investment is CAD $2,500 “unless a participant provides additional support to evidence that it is an eligible investor or an accredited investor”. There is an assumption that all participants are not “eligible investors” or “accredited investors”, as such terms are defined in NI 45-106. If an amount is paid in Ether, the value of Ether will be determined at the time that such subscriber completes the onboarding process and is approved for participation in the TGE.
  • Token holders will receive updates from management of the filer regarding the milestones for development of the platform and any other material events concerning the business of the filer, including all disclosure required pursuant to NI 45-106 and other applicable securities laws, and annual audited financial statements.
  • Token holders will not have any voting rights in respect of the filer’s governance or operational matters; however, they will have certain voting rights on the entities entitled to use the platform.
  • Immediately following the completion of the TGE, the Filer will seek to become a registrant pursuant to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligationsand any exemptive relief that may be required.
  • The platform will not be launched prior to the filer becoming a registrant and obtaining any exemptions or licenses that may be required.

The OSC granted exemptive relief from the dealer registration requirement for a 12-month period, provided that the filer complies with the following conditions:

  • Know Your Client investigations and suitability review will be conducted on the assumption that none of the participants will qualify as “eligible investors” or “accredited investors”. If an token buyer seeks to purchase an amount exceeding CAD $2,500, then he/she must be an “eligible investor” or “accredited investor”, as such terms are defined in NI 45-106.
  • The tokens issued in the TGE will not be listed and traded on any exchange, including cryptocurrency exchanges, unless approved by the OSC.
  • The filer will deal fairly, honestly and in good faith with token buyers.
  • The filer will establish and maintain policies and procedures to manage the risks associated with its business.
  • The filer will not provide investment recommendations or advice to token buyers.
  • Besides filing required reports with the OSC, the filer must provide enhanced reporting to the OSC including regarding token buyer complaints, average subscriber purchase amounts, and regional subscriber purchase details.

We take very little comfort in the OSCs proclamation that while the decision should not be viewed as a precedent for other applicants in the jurisdictions of Canada, it will endeavor to provide assistance to fintech startups to reduce the time and cost of getting innovative ideas to market. Instead, we read into this language as a harbinger of increased scrutiny and attempts to apply the public offering restrictions to those TGEs which may not even come close to satisfying the Pacific Coast Coin test (Pacific Coast Coin Exchange of Canada v. OSC, [1978] 2 SCR) explained in our previous blog.

If you are considering a TGE or ICO, please contact the lawyers at Grinhaus Law Firm so that we can assess the level of risk and compliance required, review your White Paper and ensure that you are on the right track.