As reported in our previous notice, the Ontario Securities Commission (“OSC”) recently introduced Rule 72-503 Distributions Outside Canada (“Rule 72-503”), which came into force on March 31, 2018, and set out rules applicable to the issuances of securities outside of Canada.
While Rule 72-503 contemplates distributions of traditional securities, an important corollary to consider is how these changes will impact token issuers in Ontario who intend or desire to issue tokenized securities outside of Canada.
Prior to Rule 72-503, issuers in Ontario who distributed securities outside of Canada relied on the principals of Interpretation Note 1 Distributions of Securities of Ontario (the “Note”) which set out certain guidance with respect to how Ontario securities laws may apply to such distributions. However, the Note left some areas of ambiguity. Rule 72-503 was adopted to provide issuers with more clarity as to when Ontario prospectus requirements would not be applicable.
Rule 72-503 provides four exemptions from the requirement to file a prospectus in Ontario where securities are distributed outside of Canada, two of which bear special mention as they may be applicable to security token offerings:
- Foreign Public Offering Exemption – This exemption is available in respect of public offerings of securities made in the U.S. or “specified foreign jurisdictions”, provided that an offering document which qualifies, registers or permits the offering of such securities and a receipt, notice of effectiveness or similar acknowledgement of regulatory approval of the offering document has been obtained.
- Restricted Canadian Resale Exemption – This exemption is available in respect of distributions of securities into a jurisdiction outside of Canada, provided that the issuer has materially complied with the disclosure requirements applicable under that jurisdiction’s securities laws – or the distribution is exempt from such law.
The OSC has formalized these rules on the basis that investors outside of Canada will ordinarily expect to rely on the securities laws of the foreign jurisdiction in which they are located and, as such, compliance with Ontario securities laws may be unnecessarily duplicative.
How may these rules apply to security token offerings?
A number of countries have started to develop and publish guidance and regulations which will permit issuers to legally distribute tokens, potentially including security tokens. However, regulators in Canada have not yet provided any comprehensive guidance on the distributions of regulatory compliant security token offerings. The result has been a lack of clarity regarding how Ontario regulators would treat Ontario-based issuers distributing security tokens abroad.
If Rule 72-503 can be relied on by token issuers in Ontario, it will provide certainty that issuers are exempt from the Ontario prospectus requirements with respect to the distribution of security tokens into jurisdictions where such distributions are permitted.
Issuers in Ontario relying on the Restricted Canadian Resale Exemption to issue security tokens are subject to two additional requirements:
- Reporting Requirements: Issuers must file a Form 72-503F with the OSC within 10 days of the distribution date. This form requires a description of the type of security being offered, issuer information and address, purchase price and date of distribution. Importantly, for some token issuers, this form does not require the issuer to provide personal information of the individual subscribers.
- Resale Restriction: The tokens offered would be subject to resale restrictions with respect to sales back into Canada, unless the issuer is and has been a reporting issuer in a Canadian province or territory for the four months preceding the resale and at least four months have elapsed since the distribution date.
Restrictions on flow-back to Canada
While not specifically set out in Rule 72-503, the OSC further reminds issuers that they expect the issuer to take sufficient measures to make it reasonable to conclude that the offered securities “come to rest” outside of Canada, meaning that it is unlikely such securities will be re-distributed or resold back into Canada by the original purchaser. Companion Policy 72-503 Distributions Outside Canada sets out several examples of measures that may be taken by issuers to show compliance with this principal:
- A restriction in an underwriting or agency agreement that prohibits the sale of securities to any person or company in Canada, except pursuant to the prospectus exemption;
- Clear statements in the offering document that the securities have not been qualified for distribution in Canada and may not be offered or sold in Canada during the course of their distribution;
- The distribution is conducted as a broad-based offering and it is reasonable to expect that a trading market for the offered securities outside Canada will develop; or
- Purchasers outside Canada provide representations and warranties or are given notice to the effect that they are purchasing the securities with investment intent and not with a view to distribution, and such representations are reasonable in view of the nature of the surrounding circumstances.
While these examples reflect practices for traditional securities, issuers of security tokens should consider how this guidance can be applied to a security token offering.
A word of caution
The OSC has cautioned that these exemptions are intended only for distributions made in good faith outside Canada, and not as part of a plan or scheme to conduct an indirect distribution to a person or company in Canada. It is imperative that issuers not lose sight of the ultimate principals underpinning Rule 72-503 and take care to ensure their materials align with the principals set out therein.
Further, as regulation continues to develop in this area, different jurisdictions may have different interpretations as to whether a token may be a “security” or not. It is unclear which regulations would be applicable in a circumstance where the OSC deems a token a security, but such token is distributed into a jurisdiction where it is not considered a security.
Issuers in Ontario should also be mindful that where the OSC becomes aware of conduct that may “bring the reputation of Ontario’s capital markets into disrepute or otherwise impair its mandate”, the OSC may exercise its powers to take “appropriate action” against issuers or any individuals in Ontario who may be deemed to be the “mind and management” of an issuer.
Ultimately, while these rules may provide a path forward for Ontario issuers issuing security tokens into foreign jurisdictions where security token regulations have been developed, the OSC reserves the right to take action against actors and issuers in Ontario in any instance in which they feel such action is warranted to protect the reputation of Ontario’s capital markets or on public policy grounds. Tread carefully.