This year is going to be a Happy New Year for The BitCoin Fund (the “Fund”), whose final prospectus was approved by the Ontario Securities Commission (OSC). It is the first public bitcoin fund to be cleared by any Canadian securities regulator.
The Bitcoin Fund is a public investment trust that invests in crypto-assets, the most famous of which is the eponymous bitcoin, a decentralized currency that is not issued by any government or bank (for more background on bitcoin, please see this Siskinds note).
The Bitcoin Fund offers investors the opportunity to ride the highs and lows of bitcoin without directly buying the currency. It is managed by the Canadian fund manager 3iQ Corp. and utilizes a third-party price index to value the Fund’s bitcoin. While the Fund is not the first crypto-currency investment fund, it is the first publicly-traded fund cleared in Ontario.
There are strict securities regulations for public investment trusts. To offer securities to the Ontario public, an investment fund must first receive approval from the OSC for a preliminary prospectus. The OSC may require some changes to the preliminary prospectus. If these changes are made, the final prospectus can be submitted. If the final prospectus is approved, then securities can be issued to the public (subject to continuous disclosure requirements).
3iQ had been in talks with the OSC since late 2016 to discuss the issuance of a receipt for the final prospectus of the Fund. In February 2019, the Fund’s prospectus was denied a receipt (i.e., rejected) because bitcoin was found to be a “novel asset currently in its nascent state”. Specifically, the OSC Director rejected the Fund on the grounds that bitcoin was an illiquid asset and it was not in the public interest to approve it.
Regarding illiquid assets, Section 61(2)(a) of the Ontario Securities Act(the “Act”) allows the Director to refuse to issue a receipt for a prospectus if it “does not comply in any substantial respect with any of the requirements of this Act or the regulations”. The Director found that bitcoin was an illiquid asset because it did not trade on established exchanges. Under National Instrument 81-102, investment funds can only contain a limited amount of illiquid assets. The Fund exceeded these limits.
As for public interest, Section 61(1) of the Act allows the Director to refuse to issue a receipt if “it is not in the public interest to do so”. One of the animating principles of the Act is investor protection, and the Director found “the valuation, safeguarding and liquidity of bitcoin” raised significant investor protection issue, such that issuing a receipt would not be in the public interest. It was alleged that there was unmanageable price manipulation in crypto-currency markets.
The BitCoin Fund challenged the Director’s decision.
On October 29, 2019, Commissioner Lawrence Haber set aside the OSC Director’s decision on the grounds that the Director failed to meet its burden of proof. He concluded that “it is not the job of securities regulators to ban speculation or risk-taking “and that the novelty of bitcoin as an asset was not sufficient to justify a ban. The Commissioner rejected arguments that Fund held too many illiquid assets and would have a detrimental effect on the public interest.
Regarding illiquid assets, the Commissioner found that there were sufficient “market facilities [that] provide a liquid market for promoting price discovery for valuing the Fund’s assets”. Therefore, bitcoin was not an illiquid asset.
On the public interest point, the Commissioner found that the risks to investors were minimal because the Fund would only invest in bitcoin (not other types of crypto-currency) and would only transact business on regulated exchanges. Therefore, the Director’s decision was set aside.
At first glance, the OSC seems to have gone the opposite way of the American Securities and Exchange Commission, which had rejected a bitcoin-based ETF. But as the Commissioner noted, “SEC decisions related to different products, with different structures.” A non-redeemable fund is not the same as an active ETF – the risk of price manipulation is higher for dynamic funds like ETFs.
The Commissioner’s position is a bullish view of financial innovations: Bitcoin, pot stocks and crypto-currency exchanges are all fair game for investors looking for the OSC’s regulatory stamp of approval. As the Commissioner put it, the OSC should be trying to tame the wild west by “professionalizing investing in risky assets”.