Written by Conrad Druzeta, Michael R. Whitt and Andrew Pollock
On October 17, 2017, the Ontario Securities Commission (OSC) issued its decision In the Matter of Token Funder Inc. The decision granted exemptive relief from the dealer registration requirement in order to allow Token Funder to launch an initial token offering under the offering memorandum prospectus exemption rules. The OSC decision applies in all of the provinces and territories of Canada.
Over the past year, it is estimated that initial coin offerings (ICO) and initial token offerings have raised billions of dollars globally. Initial offerings are a way for blockchain startups to raise money without seeking more traditional venture financing. The majority of purchasers of tokens have purchased them solely to engage in passive investment. Others have purchased so-called "utility tokens" on the promise these tokens may be used to purchase access to development resources or platform space provided by the token issuer.
Some offerings have been done under crowdfunding exemptions; other issuers have taken the view (rightly or wrongly) that their coins or tokens are pure utility tokens and therefore not securities subject to securities laws, while other offerings have simply proceeded in breach of securities laws, often with very limited disclosure. Occasionally, there has been clear indicia of fraud.
Securities regulatory authorities have been grappling with balancing the benefits of new fintech and blockchain technologies against the need for fair and efficient capital markets. Recently, guidance has been increasingly clear. In August, the Canadian Securities Administrators (CSA) stated that: "Many of these cryptocurrency offerings involve sales of securities."1 In July 2017, the U.S. Securities and Exchange Commission (SEC) issued an investor bulletin warning investors of the dangers of initial coin offerings. The SEC stated that "depending on the facts and circumstances of each individual ICO, the virtual coins or tokens that are offered or sold may be securities. If they are securities, the offer and sale of these virtual coins or tokens in an ICO are subject to the federal securities laws."2
In February 2017, to try to respond to the needs of startups while maintaining investor protections, the CSA launched their Regulatory Sandbox Initiative. According to the CSA, "the objective of [the] initiative is to facilitate the ability of …businesses to use innovative products, services and applications all across Canada, while ensuring appropriate investor protection."3 Token Funder obtained its exemption by working with members of the Regulatory Sandbox Initiative.
Token Funder Offering
According to the OSC decision, Token Funder "was established for the purposes of creating a platform, known as the smart token asset management platform ("STAMP")." This platform is intended to "facilitate third-party issuers raising capital through the offering of blockchain-based securities, including tokens and coins. In addition to facilitating issuances of blockchain-based securities, STAMP intends to, among other things, provide token and coin management and governance services for issuers and…provide for certain transferability of tokens and coins to ensure that a particular token or coin can achieve the access or use function for which it has been principally created." Token Funder intends "STAMP to operate as a platform to facilitate the raise of capital in accordance with" the rules relating to prospectus exemptions or crowdfunding.
Token Funder sought an exemption from the dealer registration requirement, which was granted for a 12-month period, provided that the following conditions are met:
- Token Funder must comply with the terms of the OSC decision (which contains a summary of the main offering terms).
- The offering will be made under the offering memorandum prospectus exemption. Know Your Client investigations will be conducted on the assumption that none of the participants will qualify as "eligible investors" or "accredited investors". Individual investments will be capped at C$2,500 unless the assumption can be rebutted. In addition, investors will be surveyed to ensure that they have a detailed understanding of cryptocurrency and digital token offerings.
- The tokens issued in the offering will not be listed and traded on any exchange, including cryptocurrency exchanges, unless approved by the OSC.
- Token Funder will deal fairly, honestly and in good faith with its investors.
- Token Funder will establish and maintain policies and procedures to manage the risks associated with its business including regarding the Ethereum blockchain, cybersecurity and conflicts of interest with investors.
- Token Funder will not provide investment recommendations or advice to investors in Token Funder tokens.
- Besides filing reports of exempt distribution with the OSC, Token Funder must provide enhanced reporting to the OSC including regarding investor complaints, average subscriber purchase amounts, and regional subscriber purchase details.
The holders of tokens issued by Token Funder may receive distributions if approved by the directors. Token Funder must also deliver continuous disclosure typically required of a distributing company. However, such information will be provided by email and on Token Funder's website.
The exemptive relief granted was, among other things, based on Token Funder agreeing to apply to become a registrant promptly following the initial offering. Absent such registration, Token Funder cannot facilitate intended capital raising efforts by issuers and, in fact, the OSC decision provides that the STAMP platform may not be launched prior to Token Funder becoming a registrant.
Although the OSC stated that its decision in Token Funder should not be viewed as a precedent, it suggests that the OSC and the CSA will work with suitable tech startups to provide assistance and exemptions to reduce the costs of first round funding and to facilitate novel business ventures.
1 CSA Staff Notice 46-307, Cryptocurrency Offerings, August 24, 2017
2 SEC Investor Bulletin: Initial Coin Offerings, July 25, 2017
3 The Canadian Securities Administrators Launches a Regulatory Sandbox Initiative, Press Release, February 23, 2017