OSC Innovation Office -- exemptive relief provided to an Ontario corporation from the requirement to register under Ontario securities legislation -- Filer will conduct a time-limited pilot test of its innovative business that involves operating a platform that utilizes blockchain technology to facilitate the distribution of tokens that represent a fractional ownership in a real estate asset -- there has been a recent growth of tokenized real estate businesses and offerings and the Filer has not identified another registered Canadian company that utilizes blockchain technology tokenize interests in real estate asses in the same manner -- pilot test will involves one single property located in the Greater Toronto Area and will only be available to a limited number of accredited investors that complete the Filer's onboarding process -- the property will be owned by a special purpose vehicle that is a limited partnership under the laws of Ontario -- token holders will be limited partners of the limited partnership -- the property will be rented and token holders will receive regular distributions of rental income less expenses -- Filer must submit an application to become registered within 9 months from the date of the decision -- relief expires 18 months from the date of the decision -- relief provided from section 25 of the Securities Act (Ontario).
Applicable Legislative Provisions
Securities Act, R.S.O 1990, c. S.5, as am., s. 25.
National Instrument 45-106 Prospectus Exemptions.
National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations.
Ontario Securities Commission Rule 72-503 Distributions Outside of Canada.
July 26, 2022
IN THE MATTER OF
THE SECURITIES LEGISLATION OF ONTARIO (the Jurisdiction)
IN THE MATTER OF
FRACTIONVEST INC. (the Filer)
The Ontario Securities Commission (the OSC), through its Innovation Office, engages with businesses that have innovative products, services or applications that benefit investors. The OSC LaunchPad support program assists businesses with navigating regulatory requirements and engages in discussions on tailoring regulatory requirements, including time-limited registration or exemptive relief from securities law requirements, to allow them to test their innovative business models.
The Filer has developed a permissioned blockchain-powered platform (the Platform) that provides a system for tokenizing real estate assets and issuing tokens that represent fractional ownership in a real estate asset (the Tokens).
Globally there has been a recent growth of tokenized real estate businesses and offerings. The Filer seeks to make real estate ownership more attainable by utilizing blockchain technology to remove some of the friction of investing in real estate and offer a way for investors to purchase a fractional interest in a specific property, benefit from any increase in the value of the property and receive a proportional share of any rental income without the significant upfront costs and efforts typically required. The Platform will allow for the issuance of Tokens on the blockchain that relate to a specific property, provide an immutable record of ownership of the Tokens, and use smart contracts to define ownership rights, hold periods and transfer restrictions. The Filer has not identified another registered Canadian company that utilizes blockchain technology to tokenize and fractionalize interests in real estate in the same manner.
The OSC recognizes that to keep abreast of and facilitate innovation and limit risks to investors, an environment to conduct commercial tests of novel business models, products and services is required. The Filer is seeking exemptive relief, as described below, to conduct a time-limited pilot test involving one property in order to test the Platform in a controlled environment to address any technical issues and assess potential technical improvements prior to launching the Platform (the Pilot Test).
Relief Sought for Time-Limited Pilot Testing
The OSC has received an application from the Filer (the Application) for a decision under the securities legislation of the Jurisdiction (the Legislation) exempting the Filer from the requirement to register as a dealer under the Legislation in respect of the operation of the Platform and other activities in connection with the Pilot Test(the Exemption Sought). The Exemption Sought will expire on the earlier of the date that is 18 months after the date of the Decision, or the date on which the Filer becomes registered.
Terms defined in National Instrument 14-101 Definitions have the same meaning if used in this decision unless otherwise defined.
1. The Filer is a corporation incorporated under the laws of Ontario, with its registered office located at 100 King Street West, 1 First Canadian Place, Suite 6200, Toronto, Ontario, Canada, M5X 1B8.
2. The Filer is a financial technology start-up that seeks to democratize real estate ownership by connecting the benefits of blockchain technology to real estate transactions to provide potentially better outcomes for investors.
3. The Filer is not a reporting issuer under applicable securities laws of any of the provinces or territories of Canada (the Canadian Jurisdictions) and has no present intention of becoming a reporting issuer in any of the Canadian Jurisdictions.
4. The Filer is not in default of securities laws of any of the Canadian Jurisdictions.
5. Following the completion of the Pilot Test, the Filer intends to seek registration in Ontario and will consider registration in other Canadian Jurisdictions on a case-by-case basis as perceived demand warrants.
6. The Platform is a permissioned blockchain-powered platform, built on the Ethereum network. The Platform provides an end-to-end process for tokenizing the ownership rights of a real estate asset, issuing Tokens to investors, allowing for the digital recording of ownership of Tokens on the blockchain, and facilitating the distribution of rental income. The Platform may also facilitate the transfer of Tokens, however transfers of Tokens are restricted for the Pilot Test. The Filer intends that, once the Filer is registered, the Platform will facilitate transfers of Tokens as permitted by securities legislation.
7. The Filer believes that the Platform can offer the potential benefits of process efficiency and reduced costs from automation of processes as a result of smart contracts defining ownership rights, rules related to the Token issuance, hold periods and transfer restrictions. The Platform has the potential to increase the speed of issuing securities, distributing rental income and managing corporate actions, lower the cost of entry for real estate ownership and provide access to a broader group of investors and to liquidity and secondary market opportunities, where permitted by securities legislation.
8. The Filer has formalized a partnership through Fractionvest Dubai with a third party blockchain software service provider to support the initial development and roll-out of the Platform.
9. The Platform enables the issuance of Tokens on the Ethereum blockchain. The Tokens follow the ERC-20 (Ethereum Request for Comment 20) token standard used by smart contracts for token implementation on the Ethereum blockchain. It defines a set of basic guidelines and functions for token ownership and immutable transferability that any new token created on the Ethereum network using that standard must follow. The Tokens will be enhanced ERC-20 tokens.
10. The Platform includes smart contracts developed by the Filer that will place specific restrictions on the investors and the Tokens, including:
a. requiring all prospective investors to complete the Filer's onboarding processes (described below) and be verified and approved by the Filer before being permitted to purchase Tokens;
b. placing limits on the amount and/or value of Tokens that an investor may purchase; and
c. restricting investors from transferring their Tokens for a specified period of time;
11. The blockchain software service provider will conduct an audit review of the Platform's smart contracts to ensure they are operating as intended prior to the Pilot Test.
The Pilot Test
12. The Filer seeks to conduct a Pilot Test involving the operation of the Platform and the issuance of Tokens that represent the economic rights of ownership of a real estate asset (the Security Token Offering).
13. The Filer's objective for the Pilot Test is to gather data and operational feedback, address any issues and assess potential technical improvements. Specifically, the Filer would like to test the effectiveness of the Platform, including the creation of Tokens, the implementation of transfer restrictions and the functioning of the smart contracts, with real-world constraints, such as handling banking connections, varied inputs simultaneously at different stages of a user transaction, different user operating systems and environments, and transaction throughput on a live permissioned blockchain, which are not as rigorously tested in a simulated test environment. The Pilot Test will allow the Filer to address any issues with a limited number of accredited investors before making the Platform available more broadly.
i. The SPV and the Property
14. The Filer intends to establish a single purpose special purpose vehicle (the SPV) as a limited partnership under the laws of Ontario, Canada. The Filer will be the general partner of the SPV and the Tokens will represent limited partnership interests of the SPV.
15. The Tokens are securities under the Legislation.
16. The SPV will be the issuer of the Tokens and sole legal owner of the Property (as defined below). The SPV will not own more than one property and will not carry on any business other than owning the Property and issuing the Tokens.
17. The Filer will not be a limited partner of the SPV and will not own any Tokens.
18. The Filer, in its capacity of general partner of the SPV, will hold legal title to the Property on behalf of the SPV.
19. The subject real estate asset for the Pilot Transaction (the Property) will have the following characteristics:
a. located in the Greater Toronto Area;
b. market value in the range of $500,000 -- $1,500,000;
c. a single-family home or condominium unit; and
d. free of any mortgage or other financial lien;
ii. Investor Onboarding Process
20. All investors on the Platform will be required to complete an onboarding process, including identity verification, anti-money-laundering (AML) and sanctions screening, conducted through Onfido, an eKYC service provider which has an established partnership with the Filer's blockchain software service provider for such services.
21. Only "accredited investors" as defined in section 73.3 of the Legislation, or the equivalent under the legislation of the jurisdiction of the investor, will be permitted to purchase Tokens.
22. The Filer will comply with the requirements of the exemption in section 2.3 of National Instrument 45-106, including by requiring investors to confirm their accredited investor status and, where applicable, complete the risk acknowledgement in the required Form 45-106F9 Form for Individual Accredited Investors.
23. The Filer uses technology, including a questionnaire required to be completed by investors via the Platform, to facilitate the determination of whether a purchase of Tokens is suitable for an investor.
24. Each prospective investor must complete the steps described in paragraphs 20, 22 and 23 and be verified and approved by the Filer before they are permitted to purchase Tokens.
25. The maximum investment amount for an accredited investor in Ontario is $150,000, however the amount that may be suitable for an investor to invest may be lower than the maximum investment amount.
26. The total number of investors participating in the Pilot Test and Security Token Offering will vary dependent on the Property's features and individual investor demand. The Filer anticipates that the total number of investors will be in the range of 5 -- 50, but no more than 100.
27. Though the Filer expects a majority of the investors to be residents of the Jurisdiction, the Filer may permit non-resident international investors to purchase Tokens provided that they complete the required onboarding processes described above, and the Filer is satisfied that they are permitted to participate in the Security Token Offering under the laws of the jurisdiction of their residence, and the Filer is in compliance with the requirements of that jurisdiction in relation to the offer the Tokens to investors in that jurisdiction. The Filer will comply with the requirements of Ontario Securities Commission Rule 72-503 Distributions Outside of Canada for any distributions of Tokens to investors outside of Canada.
iii. The Security Token Offering
28. The Filer will identify an independent third-party vendor for the target Property, which may be an individual vendor known to the Filer. The vendor will not be a director, employee, or advisor of the Filer, but in the case of any personal affiliation between a director, staff member, or advisor of the Filer and the vendor of the Property, the transaction will be managed as an arm's length commercial transaction and the Property will be offered and purchased at market value.
29. The Filer will use the services of an independent third-party valuator to prepare an appraisal for the Property and determine the purchase price of the Property. Based on the purchase price, the Filer will set an offering amount for the Security Token Offering, including all acquisition costs, expenses and fees to acquire the Property (the Offering Amount), and an offering period (the Offering Period).
30. Investors that are verified and approved by the Filer will be provided with the Token Purchase Agreement (defined below) and other documents relevant to the Security Token Offering and the Pilot Test, via the Platform. Investors interested in purchasing Tokens will be required to sign the Token Purchase Agreement using a secure electronic signature application via the Platform.
31. The Filer expects the Security Token Offering to involve the issuance of 100,000 Tokens. The price of the Tokens at the time of issuance will be determined based on the Offering Amount, divided by the number of Tokens issued.
32. No additional Tokens for the Property will be created or issued after the Security Token Offering, except as may be necessary to represent any subsequent approved capital contributions in respect of material works to the Property.
33. The Filer requires investors to purchase Tokens by transferring Canadian or U.S. dollars to the Filer's bank account. The funds will be held in escrow at a Canadian custodian (as defined in section 1.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103)) in a trust account for the benefit of the investors, separate and apart from the Filer's or its subsidiary's own assets, until either (i) the Offering Amount is raised, in which case the Property acquisition and Security Token Offering will close simultaneously and the Tokens will sent to investors' wallets, or (ii) the Offering Amount is not met within the Offering Period or the Property becomes no longer available for sale, in which case investors' escrowed funds will be returned to them.
34. The Filer will not accept crypto assets as payment for Tokens.
35. The Filer will provide each investor with a two-day right of withdrawal during which time they may cancel their Token purchase.
36. The Tokens are subject to a minimum hold period of two years. The Filer will not facilitate any transfers or resales of Tokens, except in limited special cases where an investor needs to sell their Tokens because of an unforeseen financial need. In these circumstances the Filer will work with the Token holder to find a buyer for the Tokens provided that they buyer satisfies the Filer's Investor Onboarding Process described in paragraphs 20-27 above.
37. There is no market for the Tokens distributed by the Filer and the Filer has no present intention of listing Tokens on any marketplace (as the term is defined in National Instrument 21-101 Marketplace Operation).
38. As the Tokens are subject to a hold period and for the purpose of the Pilot Test the Filer will hold the private keys on behalf of the investors. The private keys will be stored by the Filer in a Hashicorp Vault Cloud Hardware Security Module (HSM) which is not connected to the internet. Once the Filer is registered it intends that investors will be offered the option to hold their own private keys.
39. Investors will be able to see the number of Tokens they hold in their account on the Platform, however they will not be able to transfer the Tokens. The Filer, in its capacity as general partner of the SPV, will maintain a centralized register of Token holders (limited partners of the SPV), which will include the name and address of each investor and the address of the investor's digital wallet on the Ethereum network where the Tokens are held. A copy of the register will be held with the Filer's legal counsel.
40. If the Tokens are lost or stolen, the Filer will burn the Tokens and reissue them to the investor's wallet.
41. The Property will be rented and managed by an independent third-party property manager.
42. Rental income, net of expenses and reserves, earned by the SPV will be distributed to Token holders from time to time. Token holders will receive net rental income from the Property pro rata to their Token holdings.
43. The Security Token Offering for the Property includes a maximum investment term of 5 years (the Investment Term), at the end of which Token holders will determine through a voting process whether the Property should be sold by the SPV or retained for a further term.
44. Holders of the Tokens will be entitled to vote for:
a. approval for carrying out any material works to the Property, which incur costs in excess of 5% of the original cost of the Property or involve a period of longer than two calendar months without rental income;
b. approval for any modification in the initial Investment Term of the Property;
c. approval for the sale of the Property; and
d. approval for the appointment, change or removal of the property manager of the Property.
45. In order to purchase the Tokens, investors will be obligated to enter into a subscription agreement with the Filer and the SPV (the Token Purchase Agreement).
46. The Filer will provide investors with a copy of the limited partnership agreement of the SPV, which provides Token holders with information rights in respect of the SPV and Property, including access to the SPV's books and information about the rental income, expenses, and reserves relating to the Property.
47. Every prospective Token purchaser will be provided with an offering memorandum (the Offering Memorandum) which describes the Filer and the Security Token Offering, including key information about the Property, all acquisition related costs with a detailed transaction breakdown, anticipated net rent (showing the breakdown of total rent minus any associated fees such as property maintenance fees), and illustrative examples of how investors may calculate total or annualized return on investment through a range of potential inputs (e.g. illustrative projections of capital appreciation, net exit value), investment risk factors, a breakdown of fees payable to the Filer, a summary of the limited partnership agreement which governs the SPV, eligibility for investment and the online subscription process through the Platform.
48. The description of investment risk factors in the Offering Memorandum will include, among other risks, the illiquidity of the underlying Property, lack of any Token secondary market, mandated Token hold periods and that the expiry of the hold period does not mean there will be a market for the Tokens at that time, lack of assurance that the Filer will become registered and associated potential inability of the Filer to conduct registerable activity beyond the date that the decision expires.
49. The Offering Memorandum will describe the rights of action for a misrepresentation in section 130.1 of the Legislation.
50. Copies of the Token Purchase Agreement and the Offering Memorandum will be accessible to investors via the Platform.
51. The Filer will have a dedicated customer service email address for complaints and inquiries. Any complaint will be acknowledged within seven days and investigated and resolved within a target maximum of sixty days.
The OSC is satisfied that the Decision meets the test set out in the Legislation for the regulator to make the decision for the purposes of pilot testing this novel business.
The decision of the OSC under the Legislation is that the Exemption Sought is granted, provided that all of the following conditions are met:
a. The Filer will conduct only one issuance of Tokens representing the economic rights of ownership of a single real estate asset, the Property.
b. The Filer will limit the Security Token Offering to no more 100 investors in total.
c. The Filer will only permit "accredited investors", as defined in section 73.3 of the Legislation, or the equivalent under the legislation of the jurisdiction of the investor, that have completed the Filer's onboarding process described in representations 24-26 and have been approved and verified by the Filer, to purchase Tokens.
d. The value of the Tokens acquired by each investor does not exceed $150,000, however the amount that may be suitable for an investor to invest may be lower than the maximum investment amount.
e. The Filer will deal fairly, honestly and in good faith with all purchasers of Tokens.
f. The Filer will establish, maintain and apply policies and procedures that establish a system of controls and supervision designed to manage the risks associated with the Filer's business, including risks resulting from use of the Platform, cybersecurity breaches and potential conflicts of interest including as between the Filer, any vendor of the Property, any property manager of the Property, and/or any other service provider.
g. The Filer will ensure that any conflicts of interest will be identified and addressed in the best interests of the investor.
h. The Filer will hold all funds received by investors for the purchase of Tokens in escrow with a Canadian Custodian (as defined in section 1.1 of NI 31-103) in a trust account for the benefit of investors, separate and apart from the Filer's or its subsidiary's own assets, until either (i) the Offering Amount is raised, in which case the Property and Token acquisitions will close simultaneously and the Tokens will be sent to investors' wallets, or (ii) the Offering amount is not met within the Offering Period or the Property becomes no longer available for sale, in which case investors' escrowed funds will be returned to them, in full, and without penalty.
i. Neither the Filer nor any of its directors, officers, employees, agents or representatives will make recommendations or provide investment advice to any purchaser of Tokens.
j. The Filer will not publicly advertise the Security Token Offering, other than on the Filer's website and its social media channels.
k. The Filer will not operate a marketplace as the term is defined in subsection 1(1) of the Legislation and National Instrument 21-101 Marketplace Operation and the Filer will not list the Tokens on a marketplace or crypto-asset trading platform.
l. The Filer will not facilitate secondary trading of Tokens via the Platform and will not list the Tokens on an organized marketplace or crypto-asset trading platform.
m. In order to purchase the Tokens, investors will be required to enter into the Token Purchase Agreement.
n. The Filer will provide each investor with a copy of the Offering Memorandum which includes the information described in representation 46 and describes the rights of action for a misrepresentation in section 130.1 of the Legislation. The Offering Memorandum will describe the Decision and that the Filer will be required to be registered to operate the Platform after the date the Decision expires.
o. The Filer will provide each investor with a two-day right of withdrawal during which time they may cancel their Token purchase.
p. The Filer will hold the private keys to investors' wallets on behalf of investors in a HSM wallet not connected to the internet, separate and apart from the Filer's assets. Investors will be able to see the number of Tokens their hold in their wallet on the Platform, however they will not be able to transfer the Tokens.
q. The Filer, in its capacity as general partner of the SPV, will maintain a centralized register of Token holders (limited partners of the SPV), which will include the name and address of each investor and the address of the investor's digital wallet on the Ethereum network where the Tokens are held. A copy of the register will be held with the Filer's legal counsel.
r. No Tokens will be issued or gifted to insiders, employees, consultants, or advisors.
s. The Filer notifies holders of Security Tokens of the following events, within 10 days of the occurrence of such event:
(i) loss of any Security Tokens;
(ii) a discontinuation of the Filer's business;
(iii) any material change in the Filer's business;
(iv) any material issues identified or experienced in respect of the Filer's business or the Filer's Platform during the Pilot Test;
(v) the Filer receiving notice of any regulatory related investigations or proceedings in any jurisdiction in which it intends to offer the Security Tokens; and
(vi) a change of control of the Filer or the Property Manager;
t. The Filer will keep books, records and other documents reasonably necessary for the proper recording of its business.
u. The Filer will document and, in a manner that a reasonable purchaser would consider fair and effective, respond to each complaint received from an investor in Security Tokens.
v. The Filer will provide the OSC with:
(i) a written report every two months (within 10 days of the end of each such period) in a format acceptable to the OSC, with information relating to the Filer's progress-to-date in respect of the Pilot Test, including the milestones achieved, any issues experienced or identified and the Filer's proposed resolution to such issues, and any modifications made to the Platform or the Filer's business; and
(ii) any report, document or information that may be requested for the purpose of monitoring compliance with securities legislation and the conditions of this decision, on a timely basis, in a format acceptable to the OSC.
w. The Filer will post a copy of this decision on its website.
x. This decision may be amended by the OSC from time to time upon written notice to the Filer.
y. Before the end of the Pilot Test and no later than 9 months following the date of the Decision, the Filer will submit a substantially complete application to become registered as a dealer.
z. This Decision shall expire on the earlier of the date that is 18 months after the date of the Decision, or the date on which the Filer becomes registered.