The recent proliferation of initial coin offerings (ICOs) has been fueled, in part, by the proposition that the coins/tokens offered in an ICO are not securities and are therefore not subject to securities laws and oversight by securities regulators.
This carries significant cost and timing advantages for an ICO proponent that an issuer in an initial public offering of securities does not enjoy.
Unfortunately, the proposition is not free from doubt, and potential offerors of coins/tokens in an ICO should carefully consider whether the tokens that they are proposing to offer are more or less likely to be considered by regulators to be securities – thus making an ICO of those tokens subject to securities laws.
Although the proponents of many ICOs often go to great lengths in their whitepapers and related offering documents to specifically disavow any notion that the tokens they are offering for sale are securities, the Canadian Securities Administrators (CSA) have indicated that they will take a substance over form approach in determining whether a particular coin or token should be considered a security and made subject to regulation.
The CSA has already determined that some coins/tokens are securities for the purposes of securities laws because they are investment contracts.
In arriving at a conclusion respecting a particular ICO, the CSA will assess the economic realities of relevant coin/token and adopt a purposive interpretation with the objective of investor protection in mind.
In assessing whether or not an investment contract exists, the following four-part test from Coast Coin Exchange of Canada v. OSC5 (Pacific Coin), (which is similar to the U.S. Securities and Exchange Commission’s test in SEC v W.J. Howey Co) is instructive.
Does the ICO involve:
- An investment of money
- In a common enterprise
- With the expectation of profit
- To come significantly from the efforts of others?
ICO proponents are encouraged to undertake a thorough analysis to determine whether the coins/tokens being offered are likely to be considered securities under the current legislation before proceeding with an ICO.
Yes, my token is probably a security. Now what?
If an ICO is likely to be considered an offering of securities and therefore subject to securities legislation, one alternative is to conduct the ICO in reliance upon prospectus exemptions. This may involve limiting investor access in the ICO to accredited investors or preparing an offering memorandum (OM) in the required form to potential retail investors who cannot qualify as accredited investors.
Most ICO proponents currently publish whitepapers in connection with their ICOs. Although a whitepaper is useful for describing, among other things, the details surrounding the coins/tokens offered, they rarely comply with the requirements for OMs and other disclosure documents mandated by securities laws.
Businesses planning to conduct an ICO, whether in reliance upon prospectus exemptions or otherwise, should seek legal advice before proceeding.
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Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.