Foreign Issued Tokens Traded Over-the-Counter in Canada
Foreign Issued Tokens Traded Over-the-Counter in Canada
Part 3 of the “Smartblock Law Guide to Security Tokens, OTC Trades, Prospectus Exemptions, and Registration”
Chetan Phull · July 17, 2018
The “Smartblock Law Guide to Security Tokens, OTC Trades, Prospectus Exemptions, and Registration” is comprised of:
I. Introduction
In the present regulatory climate, Canadian blockchain teams planning an ICO / ITO are increasingly considering “ICO friendly” foreign jurisdictions for purposes of incorporation and token issuance.
One major rationale is that, after tokens are issued in another country, they are expected to flow back into Canada on the secondary market, over-the-counter (“OTC”), with no regulatory oversight because the tokens are not subject to the OTC derivative-trading rules.
However, this sentiment is misguided.
When foreign-issued security tokens flow into Canada on the OTC market, certain trading activity could still subject the corporation and its management team to regulatory and/or criminal exposure.
This is particularly true where the corporation:
has influence over the security tokens’ OTC market price (e.g. where the corporation operates the only platform where the token has any utility); or
facilitates or engages in OTC market trades of the token (e.g. through users’ token redemptions, or the corporation’s token buy-backs).
Here’s why.
II. Regulatory liability arising from OTC trades in Ontario
a. Regulatory order in the public interest
Local Canadian securities legislation applies to any trades that occur within a given Canadian jurisdiction. It makes no difference whether or not the issuer of the security is a reporting issuer in that jurisdiction. (See Companion Policy 45-106, s.1.2.)
On this basis, for security tokens traded on the OTC market in Ontario, the OSC can make a regulatory enforcement order if the blockchain company previously submitted—or was ordered to submit—to any condition of a foreign regulatory body. (See OSA, s.127(10) items 4-5; Euston Capital Corp. (Re), 2009 LNONOSC 572 at paras. 47, 56, 60-61; Chandran (Re), 2016 LNONOSC 112 at para. 22, 29).
Consider the implications of this power. It appears to mean that, if tokens are traded on the OTC market in Ontario, the blockchain company’s prior compliance with foreign ICO rules could invoke OSC scrutiny.
This is important, because the OSC can make various orders to protect the public interest—even where there is no actual breach of securities law. (See Asbestos v. OSC, 2001 SCC 37 at paras. 39-45; Cartaway Resources Corp. (Re), 2004 SCC 26 at paras. 55-56, 58-61; Fletcher (Re), 2012 LNABASC 151 at paras. 96, 98; Donald (Re), 2012 LNONOSC 546 at paras. 305-307, 323-25.)
In particular—without any actual breach of securities law—the OSC can make an immediate order in the public interest for a party to cease trading, cease acquiring securities, or implement operational changes. The OSC can also reprimand a company and order the forced resignation of a company insider. (See OSA, s.127(1) and (5)-(6).)
b. Freeze-funds order
The OSC can also freeze the funds, securities or property of a company or person for the regulation of Ontario’s capital markets (OSA, s.126(1)).
An Ontario court can thereafter affirm such action in the “public interest” (OSA, s.126(5.1)).
Contrary to a general public interest order (discussed above), a freeze-funds order in the public interest requires an actual breach of securities law (OSC v. Future Solar, 2015 ONSC 2334 at paras. 24-25, 31 (OCJ)).
This requirement may be met if the corporation contributed to misleading OTC trading activity or a misleading statement affecting an OTC market price. (See OSA, ss.126.1 and 126.2.)
Note that, depending on the facts and how urgently a freeze-funds order is required, the OSC may instead opt to prosecute these offences under the criminal law (see below).
This is because there is considerably less legal argument required to establish the requisite corporate intent for criminal offences. (See CCC, s.22.2; K.P. McGuinness, Canadian Business Corporations Law, 3d ed., Vol. 1 [Toronto: LexisNexis, 2017] at ¶8.45-8.47, 8.52; Canadian Dredge & Dock Co. v. The Queen, [1985] 1 SCR 662 at paras. 13-14, 29-33.)
After a freeze-funds order is made, the following orders can follow:
a maximum penalty against the corporation and “[e]very director or officer” of $5 million and 4 years imprisonment (OSA, ss.122(1)(c) and (3), 129.2); and
a court order to make restitution, or pay compensation, to an aggrieved person or company (OSA, ss.122.1(1), (4), and 127(1) para 10).
III. Criminal liability arising from OTC trades in Canada
Canadian criminal law includes offences which cover particularly egregious activity on the OTC markets.
Note that “persons” cannot ordinarily be convicted of offences committed outside Canada (CCC, s.6(2)), and corporations are considered persons (CCC, s.2).
This may appear to suggest that foreign corporations are immune from Canadian criminal law. However, this is not necessarily true when the foreign corporation has a senior officer acting within Canada (CCC, s.22.2).
In certain cases, therefore, a foreign company with management or operations in Canada may not be able to escape Canadian criminal law.
Moreover, criminal liability could also flow to members of the management team in Canada, depending on the circumstances. Consider that an offence is committed by anyone who commits it, and by anyone who aids, abets or counsels in its commission (CCC, ss.21-22).
On this basis, the following sections of Canada’s Criminal Code could apply to a blockchain business and its staff, further to OTC security token trades in Canada:
380(2): fraud with respect to the public market price of “anything that is offered for sale to the public”.
382: creating a false or misleading appearance of active public trading in a security, or with respect to the market price of a security.
400(1)(c): false statement made to induce investment.
These offences carry maximum imprisonment terms of 10 to 14 years for individuals. The sentence may also include an order to make restitution and public disclosure of the offence/sentence, as well as a discretionary fine (CCC, ss.732.1(3.1)(a) and (f), 734(1)(a), 735(1)(a)).
Aggravating circumstances for purposes of sentencing include an adverse affect, or potential adverse affect, on “the stability of the Canadian economy or financial system or any financial market in Canada or investor confidence in such a financial market” (CCC, s.380.1(1)(b)).
IV. Conclusion
Regulatory and/or criminal issues may arise from certain security token OTC activities in Canada.
These issues cannot be avoided by conducting a foreign ICO / ITO through a foreign corporation, particularly if management is based in Canada.
If you require assistance with an ICO / ITO, we invite you to consider our service offerings in “ICOs / ITOs and digital asset dealing / advising”.
If you require assistance with determining your exposure for cryptocurrency value manipulation, we invite you to consider our service offering in “Crypto value manipulation”.
If you require assistance with OTC-related litigation, we invite you to consider our “Litigation & Arbitration” service offerings.
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