Regulatory And Civil Consequences Of Initial Coin Offerings In Ontario

A great deal has been written recently about the possible regulatory uncertainty surrounding Initial Coin Offerings (ICOs) in Canada. In an ICO, a newly issued cryptocurrency is sold to purchasers, who acquire a right of ownership symbolized by a "coin" or token, which may appreciate in value. Depending upon the characteristics of the ownership interest that is acquired, the "coin" may constitute a security. Once issued, the way a coin may be traded is a product of its design; some coins may be freely traded on exchanges as if they were traditional securities, while others may only be traded within specific markets at established prices.

ICOs may provide a legitimate, cost-effective source of capital for start-up enterprises with significant potential upside for investors. Alternatively, they may also be a vehicle for fraud.

As bodies like the Ontario Securities Commission (OSC) and the Canadian Securities Administrators have made clear, ICOs may involve the sale of securities and could be subject to securities laws. There is a risk that an ICO could be perceived by securities regulators as improperly sidestepping securities law requirements for raising capital.

This resource addresses some of the possible regulatory and civil consequences that an issuer may encounter if it proceeds with an ICO in Ontario without either complying with securities laws or securing an exemption, in circumstances where it is arguable that the offering is a security. As set out below, failure to comply with applicable securities laws may, at minimum, defeat any economic benefit an issuer might enjoy from the offering and result in costly litigation.

Possible regulatory compliance issues

In Ontario, the distribution of coins or tokens considered to be securities requires that a prospectus be filed with the OSC and a final receipt be obtained unless an exemption from the prospectus requirement is available under the legislation, or an order exempting the offering from the need to qualify a prospectus is obtained.1 The sale of the coins or tokens may also require registration as a dealer or the availability of an exemption from registration.

If a coin issuance is determined by regulators to constitute the distribution of a security, regulatory compliance does not end with the filing of a prospectus and meeting other requirements at the time of issuance. Going forward, the coins will be subject to the comprehensive securities regulation regime, as set out in Ontario's Securities Act and the various national and multilateral instruments that govern the trading of securities in the province, including continuous disclosure obligations, and prohibitions on insider trading and tipping. It may also expose the issuer to potential civil and regulatory liability for misrepresentations made in connection with or after the ICO.

Consequences of failure to comply with regulatory requirements

The Securities Act grants the OSC broad remedial powers to address non-compliance with securities laws and regulations, including breach of the requirement in s. 53 of the Act to obtain a prospectus for a distribution of securities, and the need to be registered under s. 25 in order to trade securities. These remedial powers include the following.

Orders in the public interest

Section 127 of the Securities Act gives the OSC jurisdiction to make a wide range of orders if in its opinion it is in the public interest to do so. The courts have recognized that the Commission has jurisdiction to make an order under s. 127 even in the absence of a breach of securities law where the conduct is abusive of the capital markets.2

The Supreme Court of Canada has described the purpose of the OSC's public interest jurisdiction as "neither remedial nor punitive; it is protective and preventative, intended to be exercised to prevent likely future harm to Ontario's capital markets."3 Orders made under section 127 are designed in part to act as a deterrent:

It may well be that the regulation of market behaviour only works effectively when securities commissions impose ex post sanctions that deter forward-looking market participants from engaging in similar wrongdoing. That is a matter that falls squarely within the expertise of securities commissions, which have a special responsibility in protecting the public from being defrauded and preserving confidence in our capital markets.4

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