Global asset management quarterly - North America

Developments and market trends in North America

Publication October 2017


Coin or security? Does it matter?

Author: Mark Convery

This article summarizes recent Canadian regulatory developments affecting ICOs.


Initial coin offerings (ICOs) are all the rage. Globally there have been well over 100 ICOs and over US$1.5 billion raised, and much of it with astonishing speed. Cryptocurrency offerings have operated in, some would argue, a grey zone, and this regulatory uncertainty has been exploited. However, the regulators are catching up. In Canada the regulators of the capital markets, the Canadian Securities Administrators (CSAs) and some of the provincial securities commissions, have recently stated their views on cryptocurrency offerings and related issues. This article outlines some of these recent developments.

CSA Staff Notice 46-307

On August 24, 2017 the CSAs issued CSA Staff Notice 46-307 Cryptocurrency Offerings (Staff Notice 46-307). In Staff Notice 46-307 the CSA confirmed what we, and others, had been advising clients and prospective clients, that many of these cryptocurrency offerings involve the sale of securities and thus Canadian securities laws apply to such offerings. Moreover, in some circumstances, the offering could involve derivatives. 

If an ICO involves the sale of securities it means that compliance with applicable securities legislation is required. The result is that a prospectus is required to be prepared and a receipt obtained from the securities regulatory authorities, or a prospectus exemption must be relied upon, to issue the coins or tokens. It also may mean that the registration requirement for dealers, advisors and, if an investment fund is involved, an investment fund manager, also applies, unless an exemption is available or discretionary relief is obtained. In addition, a coin exchange may be considered to be a “marketplace” and therefore regulated like a stock exchange. Finally, if an ICO does involve securities there are also resale restrictions on the subsequent sale of any coins or tokens purchased in such offerings.

In our experience, when these complications are explained and the resulting costs and delays are quantified, the ardor for an ICO cools. However, as discussed below, this does not at all mean that an ICO is not possible. It just means it has to be done like any other offering of securities.

The CSAs, in Staff Notice 46-307, remind us that in analyzing a cryptocurrency offering it is important to look at the totality of the offering and to focus on substance over form. In Canadian securities legislation the term “security” has an extensive and non-exhaustive definition which includes the concept of an “investment contract”. This is the suggested focus for the analysis of a cryptocurrency offering. The applicable case law has developed a four element test to determine whether or not an investment contract exists and therefore securities are involved. The questions to be asked are:

  1. Does the offering involve an investment of money?
  2. Is this investment of money made into a common enterprise?
  3. Does an investor making such an investment have the expectation of making a profit?
  4. Is that profit expected to come significantly from the efforts of others?

If the answer is yes to those questions then it is a security and securities laws apply.

Prospectus requirement or exemption

A basic requirement under securities laws in Canada is the disclosure requirement of a prospectus for an offering of new securities. A prospectus has not yet been utilized for an ICO in Canada. The preparation of a prospectus takes time and is costly. There are exemptions from the prospectus requirements. A frequently used one is that one which requires investors to be “accredited investors”, e.g. institutions or high net worth individuals. The challenge with reliance on the accredited investor exemption is that it does not allow for participation by individuals who are not accredited investors which appears to be an important source of monies in most ICOs. Thus another likely exemption to be utilized is the offering memorandum exemption. This has a number of requirements, including a disclosure document (the offering memorandum) meeting certain requirements. The standard white paper for an ICO would not satisfy the offering memorandum requirement without, typically, significant additional disclosure. The offering memorandum prospectus exemption also requires a risk acknowledgement form to be signed by individuals, may, depending on the province, impose limits on the amounts certain investors can invest, and may require audited annual financial statements to be prepared. Resale restrictions would also apply. These are not insurmountable obstacles and are dealt with by other issuers of securities regularly, but they are not the practice with most international ICOs to date.

Registration requirement or exemption

Once an offering involves securities, one must determine whether any one is involved in the offering who is in the business of trading in securities. If there is, they may have to be registered as a dealer or rely on an exemption from such registration requirement. If registration is required it also triggers important obligations such as the know your client and suitability obligations on the part of the dealer. This would rule out anonymity on the part of investors and adds “friction” to the investment process. Once again, however, billions of dollars are raised in circumstances where such requirements are satisfied.

Investment funds

Frequently, cryptocurrency offerings involve what would be considered to be an “investment fund” under applicable securities laws in Canada, meaning that investors have pooled their money (i.e. cryptocurrency) to invest in cryptocurrencies or companies involved in cryptocurrencies or in blockchain technology more generally. If the offering involves an investment fund additional regulatory requirements apply including limitations on the exemptions that may be relied upon. For example, the offering memorandum exemption may not be available in certain provinces. Custodial requirements would apply and there would be valuation requirements, among several other additional requirements. These include registration as an investment fund manager for the business directing the affairs of the investment fund and, possibly, registration as an advisor for any business advising the fund.

ICO for impak Coin

In this regulatory context impak Finance Inc. launched its ICO for the impak Coin (MPK), which they describe as a new cryptocurrency with a social purpose. It is intended that this cryptocurrency would fund the development of, an online social network dedicated to the impact economy.

While the MPK has many of the attributes of a true currency, i.e., it is intended to be a method of payment within this impact ecosystem, the issuer, impak Finance Inc., undoubtedly in consultation with the securities commissions in Quebec, Ontario and elsewhere, have determined to treat the MPK as a security and offered it pursuant to prospectus exemptions including the offering memorandum exemption. Accordingly, the white paper is a formal offering memorandum. impak Finance sought and obtained discretionary relief from the securities commissions to obtain an exemption from the dealer registration requirement and the prospectus requirement on the first trades of MPK. In the MPK ecosystem a “first trade” would be the use of the MPK for payment to a merchant.

There are a number of interesting aspects to this offering and the relief obtained. It is important to note that the MPK will not be traded on an exchange and that its value will be determined by an advisory board on a quarterly basis. While there is no requirement for a dealer impak Finance is required to conduct know your client and suitability reviews for each of the participants (i.e., investors) and there are limits on the amount that can be invested by each participant of $2,500, unless the participant is an accredited investor or an eligible investor in which case it may be possible to exceed the $2,500 limit. Trades of the MPK are severely restricted. The discretionary relief has a sunset clause providing that the relief will cease to apply two years after the date of the regulatory decision.

It is interesting that impak Finance and its advisors felt it necessary to obtain the requested relief. On the face of it, it appears arguable that the MPK is not a security. If one applies the four element test described above it is not obvious from the offering memorandum that the third and fourth elements of the test apply. It does not appear that participants would contribute money with the expectation of making a profit. There is a “cash-back system” and presumably the MPK could appreciate or depreciate like any other currency which may result in a profit or loss when converted into another currency, although such value fluctuations do not appear to be an objective of the MPK ecosystem. Such value fluctuations do not necessarily make it a security. Moreover it is not apparent that this profit would come significantly from the efforts of others. Even if one concludes it is a security it is not clear why the relief from the requirement for a registered dealer was required as there does not appear to be anyone involved in the business of trading in securities in the distribution of the MPK as impak Finance is distributing them directly via its website and it appears to have a broader business purpose.

The discretionary relief obtained with respect to the offering of the MPK provides some interesting guidance as to what may be possible in terms of exemptive relief from the securities commissions for an ICO, whether it is one involving what appears to be more like a true currency or one involving a security. It is important to note that the offering of MPK had some unique features which distinguish it from the bulk of ICOs seen to date. It will be interesting to see how the principles set out in the CSA Staff Notice 46-307 and in this exemptive relief decision get stretched to fit other circumstances, particularly in more traditional ICO circumstances. While the securities regulatory authorities expressly say in the impak Finance decision that the decision “should not necessarily be viewed as a precedent for other filers in the jurisdictions of Canada” we note the order issued by the Quebec securities regulatory authority prior to the impak Finance decision prohibiting the distribution of PlexCoin and the decision subsequent to the impak Finance decision by Kik to exclude Canadian residents from participation in the distribution of the Kin tokens because of regulatory uncertainty, which may be interpreted as Kik not being willing to bear the cost, burden and delay of complying with securities law requirements in the distribution of Kin tokens.

Bitcoin investment fund manager registration

In early September the British Columbia Securities Commission announced that it had granted registration as an investment fund manager and an exempt market dealer to First Block Capital Inc. This was the first registration of an investment fund manager in Canada solely dedicated to cryptocurrency investments. Specifically First Block Capital intends to establish, manage and distribute securities of an investment fund, the Canadian Bitcoin Trust. This fund will invest only in bitcoin based on a purely passive investment strategy. It is intended that the units of the fund will be distributed pursuant to prospectus exemptions.

Because of the novelty of this business model the securities commissions have attached a significant number of terms and conditions to the registration. These include obtaining approval of the British Columbia Securities Commission before they establish or manage any investment fund, change any investment objective, change the custodian or change the entity responsible for the execution of trades in cryptocurrencies. They have also imposed significant requirements relating to the custodial arrangements for the cryptocurrencies and special reporting requirements in that regard. Interestingly, in Ontario only the registration of First Block Capital is subject to renewal at the discretion of the Director of the Ontario Securities Commission on December 31, 2019.


The advent of cryptocurrencies and ICOs and investment funds focused on cryptocurrencies is a classic example of new developments fitting into existing regulatory requirements, once the substance is analyzed as opposed to the form. To their credit, the Canadian securities regulators have been responsive with the establishment of regulatory sandbox initiatives, which supports fintech businesses seeking to offer innovative products, services and applications in Canada in a responsive and knowledgeable way. However, it appears they have taken a very broad view of what may constitute a security and thus extended their regulatory reach further than one might have expected. These recent regulatory initiatives make it clear that ICOs and investment funds focused on cryptocurrencies are possible, but the “quick buck” excitement, in Canada at least, will fade away.

United States

Tax Court finds that non-U.S. Partner is not taxable on gain from sale of interest in partnership operating a U.S. business

Author: Michael P. Flamenbaum and Hersh Verma

In a decision released on July, 13, 2017, the US Tax Court in Grecian Magnesite Mining, Industrial & Shipping Co., SA, v. Commissioner, 149 T.C. No. 3 (2017), held that a non-US partner’s gain from the redemption of an interest in a partnership that was engaged in a US trade or business was not subject to US federal income tax as effectively connected income except with respect to the portion of the gain attributable to the non-US partner’s share of the partnership’s US real property interests. In doing so, the Tax Court declined to follow IRS Revenue Ruling 91-32, 1991-1 C.B. 107, which held that a non-US partner’s gain on the sale of an interest in a partnership is ECI, and therefore is subject to US federal income tax, to the extent the gain is attributable to the partnership’s USTB.


In a decision released on July, 13, 2017, the US Tax Court in Grecian Magnesite Mining, Industrial & Shipping Co., SA, v. Commissioner, 149 T.C. No. 3 (2017) (Grecian), held that a non-US partner’s gain from the redemption of an interest in a partnership that was engaged in a US trade or business (USTB) was not subject to US federal income tax as effectively connected income (ECI), except with respect to the portion of the gain attributable to the non-US partner’s share of the partnership’s US real property interests.  In doing so, the Tax Court declined to follow IRS Revenue Ruling 91-32, 1991-1 C.B. 107 (Rev. Rul. 91-32), which held that a non-US partner’s gain on the sale of an interest in a partnership is ECI, and therefore is subject to US federal income tax, to the extent the gain is attributable to the partnership’s USTB.

Rev. Rul. 91-32 relied on an “aggregate” theory of partnerships, treating a sale of a partnership interest in effect as a sale of an undivided interest in the partnership’s assets. This IRS position was controversial, but had not previously been challenged in court. The Tax Court in Grecian, in rejecting Rev. Rul. 91-32, held that absent an explicit exception, the “entity” theory of partnerships should apply, under which a partner is treated as owning an interest in an entity that is separate and distinct from an interest in the underlying assets. Because Congress explicitly carved out exceptions to the aggregate theory in narrow circumstances, such as Section 7511 (providing for ordinary income treatment on a sale of a partnership interest to the extent attributable to certain of the partnership’s ordinary income assets) and Section 897(g) (treating the disposition of an interest in a partnership as ECI to the extent gain is attributable to US real property interests), the court reasoned that “[t]he partnership provisions in subchapter K of the Code provide a general rule that the ‘entity theory’ applies to sales and liquidating distributions of partnership interests—i.e., that such sales are treated not as sales of underlying assets but as sales of the partnership interest.” Applying the entity theory approach, the court determined the capital gain from the redemption of Grecian’s partnership interest was not ECI and therefore not taxable for US federal income tax purposes.

It should be noted that the Obama Administration proposed codifying Rev. Rul. 91-32, and the US Treasury Department had announced its intent to issue regulations applying the principles of Rev. Rul. 91-32, although legislation was never adopted and regulations have not been promulgated.

Potential impact of Grecian

Non-US investors in partnerships conducting a USTB often participate through “blocker” structures, typically US corporations, to insulate them from ECI and the resulting direct US tax filing and payment obligations. US corporate blockers are subject to US taxation on their income from partnerships, as well as on any gain from a sale of the partnership interest. To avoid corporate level gain on the sale of a partnership interest, blockers often seek to sell the stock in the blocker, although such a sale does not allow the buyer a step-up in the basis of the partnership’s assets. It may be expected that the IRS will appeal Grecian and express its intent not to follow the decision. However, if the Grecian decision is upheld, non-US investors will likely re-examine the use of blockers, with the potential to increase the use of foreign blocker corporations that will not be subject to US taxation on the sale of partnership interests under Grecian.

Even prior to any IRS appeal, Grecian represents a significant shift that may enable non-US partners disposing of interests in partnerships engaged in a USTB to consider whether their gain is not subject to US federal income tax. Further, non-US persons that have treated a sale of a partnership interest as ECI based on Rev. Rul. 91-32 should consider whether to seek a refund for taxes paid for any open tax years. 

SEC quarterly round-up

Author: Steven R. Howard

In his regular update Steven Howard discusses recent developments in the United States including the Second Circuit eliminating “meaningfully close personal relationship” element articulated in Newman for insider trading prosecutions.

SEC appoints new Investment Management Division Director and Co-Directors of the Enforcement Division

On August 31, 2017, the SEC announced that Dalia Blass has been named the new Director of the Investment Management Division. Ms. Blass joins the SEC staff from a private law firm and she returns to the SEC Staff after previously serving in the Division, most recently as the Assistant Chief Counsel. 

On June 8, 2017, the SEC announced the appointments of Stephanie Avakian and Steven Peikin as the Co-Directors of the Enforcement Division. Ms. Avakian previously served as counsel to former SEC Commissioner Paul Carey, and Mr. Peikin previously served as Chief of the Securities and Commodities Fraud Task Force in the U.S. Attorney’s Office for the Southern District of New York.

SEC conducts electronic communications sweep

In July the SEC’s Office of Compliance Inspections and Examinations started a sweep examination of investment advisers and their use of electronic communications, including text messages, snapchat, tweets, Bloomberg messaging and other devices, as well as their policies and procedures to monitor, store and review such electronic communications.

SEC issues risk alert regarding cybersecurity examinations

On August 7, 2017, the SEC’s Office of Compliance Inspections and Examinations released a risk alert regarding its staff’s cybersecurity examinations of 75 registered broker-dealers, investment advisers and investment companies. The staff’s examinations focused on six areas:  governance and risk assessment; access rights and controls; data loss prevention; vendor management; training; and, incident response.

The staff stated that, in general, cybersecurity practices have improved since the staff’s initial cybersecurity examinations in 2014, but identified weaknesses in policies and procedures, including policies that lack details and specific tailoring to advisers’ circumstances.

The staff identified the following examples of best practices.

  • Maintaining a complete “inventory of data, information and vendors”;
  • Providing “detailed cybersecurity-related instructions,” by including tracking requests for access and having policies and procedures specific to the modification of certain access rights;
  • Maintaining “prescriptive schedules and processes for testing data integrity and vulnerabilities,” by testing a patch before deploying it firm-wide and analyzing the risks related to the patch;
  • Requiring mandatory employee training at the time of hire and on a periodic basis thereafter; and
  • Reviewing and approving cybersecurity policies and procedures by senior management.

SEC issues investor alert concerning ICOs

On August 28, 2017, the SEC’s Office of Investor Education and Advocacy released an Investor Alert, regarding potential scams involving companies engaged in initial coin offerings (ICOs). These frauds include “pump and dump” schemes involving publicly traded companies that claim to provide coin and token technologies.  The SEC recently issued several trading suspensions on the common stock of First Bitcoin Capital Corp., CIAO Group, Strategic Global and Sunshine Capital because of claims these issuers made regarding investments in ICOs. The SEC cautioned investors to be wary of investing in any securities following a trading suspension.

Second Circuit Court delays Federal Court challenge to the constitutionality of the SEC’s administrative law judges

On June 1, 2017, a divided Second Circuit Court ruled that private equity manager, Lynn Tilton, cannot challenge the constitutionality of the SEC’s administrative law judges until the SEC has reached a verdict on its $200 million fraud case against her and her Patriarch Partners firm. The Second Circuit ruling concurs with rulings by the D.C. and Seventh Circuit Courts. In effect, the US Courts of Appeals agree that a plaintiff in an administrative law proceeding must make constitutionality claims first in the administrative proceeding which are subject to review by the administrative regulator, in the Tilton case, the SEC, after which an appeal to the federal Appellate Courts is permissible.

The constitutional issue in the Tilton case concerns the claim that the SEC’s administrative law judges are improperly installed by the personnel department of the SEC and not properly appointed by the U.S. President or the SEC Commissioners in accordance with the U.S. Constitution’s Appointments Clause. Without “a split in the Circuit Courts”, timely review by the U.S. Supreme Court becomes less likely.

DOL proposes 18-month delay of effectiveness date for  remaining provisions of fiduciary rule exemptions

On August 31, 2017, the Department of Labor (DOL) published in the Federal Register a proposal to delay from January 1, 2018 to July 1, 2019 the effectiveness date for the remaining conditions of the “Best Interest Contract” Exemption, Principal Transactions Exemption, and Prohibited Transaction Exemption 84-24 for Annuities of its Fiduciary Rule. The proposal seeks public comment on the structure and duration of the delay, as well as an extension of the temporary enforcement policy which is currently in place. The DOL has requested comments by September 15, 2017.

On August 30, 2017, the DOL issued Field Assistance Bulletin 2017-03 announcing the DOL’s enforcement policy for the arbitration provisions of the BIC Exemption and Principal Transactions Exemption. The DOL stated that it will not pursue a claim against a fiduciary based on a fiduciary’s failure to satisfy the arbitration provisions of these exemptions.

In U.S. v Martoma, Second Circuit eliminates “meaningfully close personal relationship” element articulated in Newman for insider trading prosecutions

On August 23, 2017, the U.S. Court of Appeals for the Second Circuit issued a ruling in the case of U.S. v Martoma, upholding the 2014 conviction of former S.A.C Capital Advisors trader Mathew Martoma for securities fraud and insider trading. The Second Circuit ruling refers to several earlier landmark cases in the evolving jurisprudence regarding insider trading, including U.S. v Newman, upon which Martoma had drawn heavily in his defence. In the view of the Second Circuit, the Supreme Court’s ruling in Salman v U.S. supersedes and repudiates certain of Newman’s highly specific requirements to establish insider trading violations, including Newman’s “meaningfully close personal relationship” criterion. The ruling in Martoma is significant for investment advisers and traders because it weighs the differing legal standards under Newman and Salman and affirms a significantly lower bar for pursuing insider trading charges. This marks a decisive shift in a body of jurisprudence around insider trading that has evolved in numerous directions since the landmark 1983 ruling in Dirks v SEC.

The Market Abuse Regulation – not just an EU compliance issue

Author: Simon Lovegrove

In this short article we discuss the extra territorial aspects on the EU Market Abuse Regulation.


The EU Market Abuse Regulation (MAR) came into effect on July 3, 2016. It replaced the EU Market Abuse Directive (MAD) and contains rules on insider dealing, unlawful disclosure of inside information and market manipulation that apply throughout the EU.

In addition, the prohibitions and requirements set out in MAR apply to acts or omissions that occur in a third country like the United States.

The extra-territorial application of the EU market abuse regime is nothing new: MAD previously had extra-territorial effect and EU Member State regulatory authorities pursued enforcement action against individuals and firms who had committed market abuse from outside their jurisdiction. However, the implementation of MAR was an important moment for the EU market abuse regime on the basis that it significantly expanded the types of financial instrument that come within the regime and sets out more detailed compliance requirements.

Extended scope

Under MAD the market abuse regime covered ‘financial instruments’ that were admitted to trading on EU “regulated markets”, such as the main market of the London Stock Exchange. The range of instruments that were caught by the definition of ‘financial instrument’ included transferable securities (covering shares in companies and other securities equivalent to shares in companies, bonds and forms of securitised debt), certain types of futures, forward agreements, swaps, options and derivatives.

However, under MAR the scope of financial instruments has been significantly expanded. The market abuse regime covers not only financial instruments traded on an EU regulated market but also financial instruments traded on a multilateral trading facility (MTF) and organised trading facility (OTF). MTFs encompass many broker-operated trading venues and listing venues that are not regulated markets, such as the Irish Global Exchange Market and the Luxembourg EuroMTF. OTFs  are a new type of trading venue that has been created by the revised Markets in Financial Instruments Directive (known as MiFID II) for the trading of non-equity instruments such as bonds and derivatives. MiFID II comes into force on 3 January 2017 and, importantly, reclassifies emission allowances as a ‘financial instrument’ which will also fall within the scope of MAR.

It is also worth noting that the market abuse regime under MAR applies to financial instruments whose price or value depends on or has an effect on the price or value of a financial instrument traded on a EU trading venue (regulated market, MTF or OTF) . This includes, but is not limited to, credit default swaps and contracts for difference. Furthermore, for the purposes of the market manipulation offence, spot commodity contracts (which are not wholesale energy products) are caught in certain circumstances as well as other financial instruments including derivative contracts/instruments which transfer credit risk, where the transaction or behaviour has an effect on the price or value of a spot commodity product. The manipulation offence also extends to conduct in relation to benchmarks.


By expanding the scope of financial instruments it is much easier for non-EU firms to be caught by the EU market abuse regime. Take for example the following scenario:

  • US company ‘A’ trades with US counterparty ‘B’ in the shares of US issuer ‘C’;
  • US issuer ‘C’ shares are listed on the New York Stock Exchange (NYSE);
  • The trades occur on the NYSE;
  • US issuer ‘C’ website refers solely to the NYSE listing;
  • US issuer ‘C’ shares also admitted to trading on an MTF in London; and
  • US company ‘A’ and US company ‘B’ will be subject to MAR, since US issuer C’s shares are also traded on the London MTF, even though trading between the two US entities occurs solely on the NYSE.


The need for non-EU market participants to have the necessary systems in place to monitor forensically the instruments they trade has become ever more important. To some extent firms will be assisted by the European Securities and Markets Authority which is required under MAR to publish a consolidated list of financial instruments that are admitted to trading or are otherwise traded on all EU trading venues. However, this list has been delayed until the implementation of MiFID II. Notwithstanding this, MAR further provides that ESMA’s consolidated list should not be treated as exhaustive so there should be some caution when relying on it.

Compliance requirements

When compared to MAD, MAR also sets out much more detailed compliance requirements including those relating to market soundings, disclosure of inside information, insider lists, market surveillance, suspicious transaction reporting and investment recommendations. Integrating the MAR requirements into the compliance framework has been a significant challenge for non-EU firms although this is important when they are engaging in activities that bring them within scope of the requirements.



All “Section” references are to the Internal Revenue Code of 1986, as amended (the “Code”).

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