On July 24, 2019, the Ontario Securities Commission (the "OSC") approved a settlement agreement with CoinLaunch Corp. ("CoinLaunch"), a service provider in the crypto-asset sector. CoinLaunch was found to have violated the dealer registration requirements of Ontario securities laws, and agreed to pay approximately $50,000 in penalties, disgorgement and costs and be barred from trading in securities and derivatives for five years.
Although North American securities regulators have taken action against parties that touted token offerings or facilitated trading in tokens that were securities, this case appears to be the first public enforcement action in North America involving "consulting services" in connection with a token offering. In its reasons, the OSC put firms in the crypto-asset industry on notice that future violations of the registration requirements of securities laws would likely result in more severe consequences for non-compliance.
CoinLaunch carried on business as a "crypto consultant", offering marketing and promotional services to prospective token issuers. CoinLaunch did not register as a dealer or seek an exemption from the dealer registration requirements under Ontario securities laws.
Between March and September 2018, CoinLaunch provided services to two token issuers: BCZERO, to raise capital for an off-road truck racing team in the Czech Republic, and ECOREAL, to raise capital for a resort in Portugal. CoinLaunch and OSC Staff agreed, and the OSC Panel accepted, that both tokens were "investment contracts" and therefore "securities" under the Ontario Securities Act. CoinLaunch was compensated in both tokens and money for its services.
CoinLaunch provided various services to the issuers of the BCZERO and ECOREAL tokens, including:
- creating and deploying the tokens on the Ethereum blockchain;
- creating promotional "white papers" for the token offerings;
- creating and managing websites to promote the token offerings;
- advising regarding the structure of the token offerings;
- booking a booth for marketing the offering at an event;
- introducing the issuers to crypto-asset trading platforms to "list" the tokens for public trading; and
- introducing the issuers of the tokens to an online forum that announced the launch of the tokens.
The OSC Panel found that the promotional services provided by CoinLaunch, taken together, constituted acts in furtherance of a trade in the tokens, though it noted that each service, considered individually, may not necessarily be an act in furtherance of a trade:
We want to emphasize that while we are satisfied that this marketing program constituted acts in furtherance of trades in these tokens, we do not intend to convey that each activity in isolation would necessarily constitute such an act. Together, however, they were instrumental and central aspects of the investor solicitation activities for these security tokens and constitute acts in furtherance of trades in such tokens.
In addition to the sanctions under the settlement, CoinLaunch's CEO undertook to delete the private keys of the tokens received by CoinLaunch as compensation, effectively rendering the tokens inaccessible and valueless. The CEO also undertook not to become or act as a director of any company engaged in or holding itself as engaging in the business of trading in securities without registration (or an exemption) under Ontario securities law.
According to the decision, prior to the OSC's investigation, CoinLaunch's principals did not understand that the company needed to be registered under Ontario securities law and only became aware of the registration requirements as a result of the investigation. As well, CoinLaunch co-operated with the investigation and took certain remedial steps, including taking down web sites promoting the tokens, ceasing its "crypto consulting" business and taking steps to wind up the company.
The Panel observed that CoinLaunch's lack of understanding of the registration requirement, the remedial steps taken by the company and the CEO's undertaking were significant mitigating factors in considering the appropriate penalties.
To date, most securities enforcement cases involving initial coin offerings have focused on token issuers, though there are examples of enforcement actions against parties other than token issuers. For example, the U.S. Securities and Exchange Commission (SEC) has taken action against the operator of the EtherDelta token trading platform for operating as an unregistered securities exchange. The SEC has also pursued a self-described "ICO Superstore" that was acting as an unregistered broker-dealer by selling tokens and two celebrities who promoted tokens contrary to anti-touting provisions of U.S. securities laws. Like those cases, the CoinLaunch case shows that regulators will take action against parties other than token issuers where there is non-compliance with securities laws.
Service providers in the crypto-asset sector should consider whether they engaging are "trading in securities for a business purpose", triggering the requirement to register as a dealer under securities laws. Guidance published by the Canadian Securities Administrators (CSA) sets out the following indicia of trading in securities for a business purpose:
- engaging in activities similar to a registrant, such as promoting securities or offering to buy or sell securities;
- intermediating trades or acting as a market maker;
- directly or indirectly carrying on the activity with repetition, regularity or continuity, even if the activity is not the sole or primary endeavour;
- being, or expecting to be, compensated for the activity; and
- directly or indirectly soliciting securities transactions or offering advice.
Importantly, a business can trip the registration trigger not only by trading or acting in furtherance of a trade, but also by holding itself out as trading or acting in furtherance of a trade. This means that a business can be subject to registration requirements simply by promoting itself as offering dealing services, even if such services are not ultimately provided.
Service providers in the crypto-asset sector should also be mindful that the definition of "trading" is interpreted broadly. Activities that have been found to be "acts in furtherance" of trading in other cases include: creating and maintaining a website designed to "excite the interest" of investors, distributing promotional materials concerning potential investments, paying referral fees to existing investors who referred to investors, and conducting information sessions with groups of investors.
Ignorance of securities laws is unlikely to be a significant mitigating factor in future cases. Although in this case the OSC viewed CoinLaunch's "asserted lack of understanding" as a mitigating factor, the OSC Panel wrote: "As a result of our decision in this matter, we expect that such an assertion is not likely to receive much weight in the future."
Similarly, monetary penalties will likely be more severe in similar future cases. Although the monetary penalty in this case was, in the Panel's words, "relatively modest", the Panel stated:
Notwithstanding the result in this settlement, firms that are found to have ignored the registration obligation in the future should be considered on notice and can reasonably expect to face more stringent consequences. Both specific and general deterrence will likely require stronger measures if such conduct arises in the future.
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