On September 28, 2017, the Canadian Securities Authorities (other than the British Columbia Securities Commission) announced the adoption of new Multilateral Instrument 91-102 Prohibition of Binary Options and the related Companion Policy (collectively, the Binary Options Rule), aimed at banning the sale of binary options having a term to maturity of less than 30 days. The ban will take effect in all Canadian jurisdictions (other than British Columbia) on December 12, 2017, subject to government ministerial approvals in certain jurisdictions.
The adoption of the Binary Options Rule follows the CSA’s establishment of a Binary Options Task Force to pursue a proactive role in dealing with fraud and misleading information associated with the sale of binary options in Canada. The Binary Options Rule is part of a multi-pronged effort by the CSA to combat binary options fraud, including a CSA website dedicated to educating investors about fraudulent binary options schemes and how they operate. Recently, the sale of binary options has been the subject of increased global media attention and the issuance of investor alerts by, among others, securities regulators in the U.S., Australia, and the U.K.
What is a Binary Option?
A binary option, as its name implies, provides for a win-lose outcome for the investor depending on the performance of an underlying interest or, the occurrence of a predetermined specified event in connection with the underlying interest (for example, a share or commodity price or the exchange rate between paired currencies). Depending on such performance or occurrence happening within a specified time (in some cases, only minutes or seconds), investors will either “win” and receive a fixed amount of money, or lose all or nearly all the money they have paid to purchase the option.
While fraudulent binary options are often designed to give a purchaser the impression that they are trading based on actual market prices or levels, a close reading of the fine print on websites that offer such options will usually uncover that prices or levels used by platforms do not necessarily reflect executable market transactions. One can only surmise that such prices or levels may be pre-programmed into platforms’ systems to ensure that, like slot machines, the house always wins in the end.
The CSA has identified that many of the products and platforms currently used for the sale of binary options are “vehicles to commit fraud”. The techniques used include highly aggressive sales calls by unregistered so-called “trading advisors”, “brokers” or “account managers”, requiring clients to disclose extensive personal information such as credit card numbers, SINs, passport numbers, etc. allegedly for “security reasons” (but more likely for purposes of identity theft), and failure to return funds which have been “won”.
Binary options products are known and sold to investors under various names including: all-or-nothing options, asset-or-nothing options, bet options, cash-or-nothing options, digital options, fixed-return options, and one-touch options. Despite the nomenclature, and the gaming overtones associated with such products, the CSA regards these products as securities or derivative contracts or instruments within their jurisdiction and mandate to regulate.
Further information about binary options can be found on the CSA’s website www.binaryoptionsfraud.ca.
Current Treatment of Binary Options
While no individuals or firms are registered to sell binary options in Canada, and no offering of binary options has been authorized in Canada, such products have been widely advertised, offered and sold to the retail public in Canada, typically through unregistered online platforms operated by companies based, for example, in Cyprus or Belize. While narrow exceptions currently exist for sales transactions with highly sophisticated purchasers, such transactions will be prohibited as well if they come within the purview of the Binary Options Rule.
Earlier this year, the Autorité des marchés financiers (AMF) had proposed a ban on the sale of short-term binary options in the Quebec market (click here for our discussion of such proposal) that was substantively similar to the Binary Options Rule. In light of the CSA’s adoption of the Binary Options Rule, including its adoption by the AMF, and in the interest of harmonizing the regulation of binary options across Canada, the AMF announced that it would not proceed with its earlier proposal. As noted above, B.C. will not be implementing the Binary Options Rule. However, currently, no person can legally sell binary options to retail investors in B.C. as described in BC Notice 2017/02 published on September 28, 2017 warning investors about the fraudulent nature of many binary options trading schemes.
Purpose of the Ban
MI 91-102 effectively prohibits advertising, offering, selling or otherwise trading a binary option having a term to maturity of less than 30 days with or to an individual or to a person or company that was created, or is used solely, to trade a binary option. The Companion Policy (CP 91-102), specifically provides that this prohibition extends to offers and solicitations through a website or other electronic means.
The Binary Options Rule seeks to accomplish several objectives including:
- To protect would-be investors from becoming victims of binary option fraud.
- To protect would be investors from the illegal promotion of extremely high risk products.
- To raise awareness among investors that the sale of such binary options is illegal.
- To disrupt the distribution of such products, including payment processing and advertisement.
- An exemption from all or part of the provisions of MI 91-102 may be granted under section 5 (except in Quebec) with or without certain conditions or restrictions.
Prohibited Binary Options
MI 91-102 defines a “binary option” as a contract or instrument that provides for only (a) a predetermined fixed amount if the underlying interest referenced in the contract or instrument meets one or more predetermined conditions, and (b) zero or another predetermined fixed amount if the underlying interest referenced in the contract or instrument does not meet one or more predetermined conditions.
CP 91-102 provides that the above definition of binary option is “intended to capture a range of products that are commonly called binary options, or are materially similar” to such products, and provides some interpretation to assist with the definition, including the following typical features of a prohibited binary option:
- Automatic exercise. No decision-making on the part of the buyer or seller once the contract is entered into.
- Underlying interest. No right to buy or sell the underlying interest which is interpreted as the “event or thing” that the value or payment obligation of the binary option is based on, derived from or referenced to which would include; an election, a benchmark interest rate, a security, index, currency, or commodity, price, rate, benchmark, or variable.
- Payout structure. Provides for a defined, discrete payout of a predetermined fixed monetary amount, not a continuous payout and not a fixed interest rate or other type of amount.
Certain contracts specifically mentioned in CP 91-102 are not considered binary options, namely:
- Contracts that are exercised without a payout of a predetermined fixed monetary amount, such as a mortgage rate guarantee.
- Insurance contracts and income or annuity contracts or instruments that are entered into with a licensed insurer and are regulated as insurance under insurance legislation in Canada or a foreign jurisdiction.
- A lottery ticket from a governmental lottery or gaming commission, regulated sports betting and licensed bingo halls.
The CSA received eight comment letters pursuant to its request for comment on proposed MI 91-102 which was published on April 26, 2017. While generally impugning the sale of binary options through “unauthorized mechanisms”, the commenters were mixed in their view regarding a complete ban on short-term binary options and made the following comments in that regard:
- Carve out. Although such products are recognized as high risk, binary options can be used as a hedge against risk, or for speculative purposes. Some commenters suggested an exception should be made for sophisticated investors and accredited investors. Further, some were of the view that such products should be permitted to be offered to all investors if done so through a registered (or exempt) dealer or, where traded on a recognized exchange or a recognized clearing agency as in the U.S. and other jurisdictions.
- Investor protection. Some commenters were of the view that a more effective approach would be to focus regulatory efforts on the perpetrators of the fraudulent activity involving binary options and not on the financial instrument itself. Some even characterized fraudulent binary options more properly as an aspect of the regulatory regime governing gambling and within the purview of the Criminal Code.
Other issues regarding the characteristics of a prohibited binary option included the following:
- Maturity date. One commenter thought the 30-day term to maturity was inappropriate for a fast moving market while two other commenters thought the Binary Option Rule should apply to all binary options regardless of duration.
The CSA’s response in general was that the Binary Options Rule is a necessary part of a multi-pronged effort to address binary option fraud that has already proven fruitful. While the 30-day term to maturity test will result in a ban on exempt market sales in Canada to sophisticated investors of any legitimate binary options caught by the Binary Option Rule, this is viewed as an “adequate balance” for regulatory purposes.