By Richard Stobbe

Securities regulators, including the US Securities and Exchange Commission (SEC) and the Ontario Securities Commission (OSC), have come down on Canadian blockchain-related (or distributed-ledger technology-based) businesses based on enforcement of traditional securities laws.  Here are a few recent enforcement cases:

How do Securities Laws apply to Blockchain and Cryptocurrency?

It’s been a few years since securities regulators in Canada have weighed in on the evolving area of Blockchain-based coin offerings and cryptocurrencies, and how they intersect with securities laws.

Generally, we know that Canadian securities laws will apply if the business that is selling the securities is either conducting business from Canada, or if Canadian investors are involved.

A cryptocurrency sale might be akin to a sale of traditional or fiat currency, such as buying or selling US dollars or silver coins.  That alone does not typically fall within the purview of the securities laws, since it’s not an “investment” in the sense of buying part of an enterprise where the expectation of profit comes from the efforts of others.  Of course a buyer of US dollars or silver coins might hope to profit if the currency goes up in value, but simply acquiring currency, without more, is a transaction governed by financial services regulators, not securities regulators.  Similarly, a buyer might acquire cryptocoins for the purpose of buying virtual products that are located within a video game platform, in which case, securities laws are likely not engaged.

However, where the coin sale is akin to an investment, similar to the traditional sale of shares of a company, then securities laws will apply.  That’s the position that regulators have taken.  The value of the coin (or the stake in the company) may rise or fall depending on how successfully the business executes its plan using the capital raised, based on the sale of the cryptocoins.  This is the application of the so-called the Howey test, which has largely been adopted into Canadian law.

The short answer? Don’t assume that an offering of a cryptocurrency or cryptocoins will avoid the application of securities laws. There are many instances where securities compliance will be required. Make sure you get experienced advice on this. Here are a few recent enforcement examples:

NextBlock Global Limited (“NextBlock”)

In a recent settlement, the OSC imposed a fine against NextBlock and its founder Alex Tapscott for misleading statements to prospective investors in a private placement that raised approximately $20 million.  The SEC also settled charges against NextBlock over the same set of facts.

In this case the infractions were not, as it turned out, related to the application of securities laws to an ICO (initial coin offering). Rather, the company was sanctioned for false statements within its offering memoranda.

NextBlock, a cryptocurrency venture capital firm paid over $1 million in fines and was pushed off its planned IPO as a result.

Kik Interactive Inc. (“Kik”)

In June, the SEC sued Kik [https://www.sec.gov/litigation/complaints/2019/comp-pr2019-87.pdf] , a Canadian social media company over a $100 million initial coin offering of “Kin”, a digital token or virtual coin, based on allegations that the ICO was not properly registered with the SEC. According to the complaint “More than 10,000 investors worldwide purchased Kin for approximately $100 million in U.S. dollars and digital assets – over half of this sum coming from investors located in the United States. However, Kik’s offer and sale of Kin was not registered with the SEC, and investors did not receive the disclosures required by the federal securities laws.”

Kik’s position is reportedly that the coin offering is not an ICO and is more akin to a token offering would be used to buy goods and services, much like the example of a virtual coin that is used to acquire something inside a virtual gaming platform.

This is one to watch as regulators and market participants bring this before the courts to clarify where the lines are drawn.

ZED Network Inc. (“ZED”)

On the other side of the, ahem, ledger, we have ZED, a Canadian company that is aiming to disintermediate global foreign exchange and remittance transfers. The company will be creating and selling tokens (the ZED token), for use on its software as a service platform (the ZED Network) to facilitate cross-border transfers.

Is this merely a token, falling outside securities laws, like a coin that would be used to trade on a gaming platform?  Deciding not to take that chance, ZED sought an exemption within the OSC’s so-called ‘regulatory sandbox’, enabling ZED to distribute the tokens to investors, in order to raise capital and establish a user base in order to carry out its ZED Network plans.

By obtaining this exemption ZED has a sort of regulatory roadmap for compliance, provided it follows all of the criteria and conditions laid out in the exemption order.  The regulatory constraints will ensure that ZED avoids the fate of Kik, but they also impose certain compliance costs and set the rails for the business model (a bit more cumbersome to amend if changes are needed to respond to the marketplace).

This is another one to watch, to see how ZED is able to progress its business within the compliance apparatus established by the OSC.

 

Calgary – 07:00 MST

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