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Bitcoin is A-OK (for prospectus issuance)

November 7, 2019

Bitcoin cleared by Ontario Securities Commission to issue final prospectus

In [Re] 31Q Corp. and the Bitcoin Fund, Commissioner Lawrence P. Haber heard a review in which Bitcoin Fund and 31Q Corp. requested that he set aside a decision of the Director of the Ontario Securities Commission’s Investment Funds & Structured Products branch denying a receipt for Bitcoin Fund’s final prospectus. The effect of the decision was that Bitcoin could not distribute its securities to the public in Ontario. The Bitcoin Fund is a non-redeemable public investment fund that plans to invest substantially all of its assets in bitcoin (using blockchain to record all transactions), while 3IQ manages the fund.

Noting that the decision was not about the merits of the plan as a potential investment and that it was not the Commission’s function to inoculate potential investors against risk, Commissioner Haber made some interesting preliminary remarks:

[5]       This application is not about the merits of bitcoin as an investment.  As with other classes of assets or undertakings or businesses underlying an issuer, the investment potential of these underlying assets, undertakings and businesses are outside the scope of securities regulation.

[6]       Bitcoin is a novel asset in an emerging and evolving market.  It is a risky asset.  Markets for novel asset classes and securities evolve over time.  Emerging markets for securities and asset classes look and feel very different from mature markets.  As markets evolve and mature, they change, either through the efforts of the market participants or through government intervention or regulation, or both.

[7]       Some novel asset classes and securities products fail.  They become tulip bulbs or dot.com’s.  Others succeed and become gold or the next great technology.

The decision below had been based in the Commission’s “broad, but not infinite” public interest jurisdiction, under which staff had raised three operational risks relating to the project:

A) Valuation and Market Manipulation

Bitcoin is a commodity, not an equity or other security and therefore the bitcoin market should be examined like other commodity markets as opposed to the standards applicable to securities markets (para 80). Market manipulation is a risk in all commodity markets (para 80), and the IFSP staff was not successful in demonstrating that bitcoin is more susceptible to manipulation than other commodity products (and not in the public interest).

B) Safeguarding of the Fund’s Assets

Bitcoin can be stolen and lost like other valuable commodities (para 85). However, the Bitcoin Fund will use a regulating Canadian trust company as its custodian (Cidel Trust Company) as well as a New York State trust company.as a sub-custodian (Gemini Trust Company, LLC), which is regulated by New York State. The safeguards in place with these two custodians, and reputable reports indicate that they have effective internal controls and cybersecurity practices, as well as disaster recovery plans (paras 87, 88).

C) Auditability of the Fund’s Financial Statements

“Investment funds that are reporting issuers are required to file financial statements that have been audited and contain an auditor’s report. When an investment fund relies on a service organization, the controls at the service organization are relevant to the investment fund’s audit.” (para 89)

Commissioner Haber concluded that the companies had a reputable auditor in place, and one which had experience auditing with regard to crypto-currencies. The operational risks identified were concerned not with the structure or management of the Fund, but with the asset itself. There are other means of acquiring bitcoin, and a ban by the Commission would not protect investors from the “unfair, improper or fraudulent practices” from which it seeks to protect the public from. The denial of the fund would also fail to promote fair and efficient capital markets and confidence in those markets. Accordingly, he held that the Director’s decision was set aside and the receipt for the final prospectus was ordered to be issued.

 

(with a contribution from Ella Hantho)

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