On December 12, 2022, the Ontario Securities Commission (OSC) issued a news release further cautioning crypto trading platforms operating in Canada on the applicability of securities laws to their operations. This news release comes amidst the OSC’s increasing oversight of cryptocurrency offerings.
When does securities legislation apply?
Previously, in January 2020, the Canadian Securities Administrators (CSA) issued Staff Notice 21-327: Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets. The CSA stated in this notice that entities that facilitate the trading of crypto assets that are securities or derivatives (Platforms) are subject to securities legislation. This includes Platforms that merely provide users with a contractual right or claim to an underlying crypto asset rather than immediately delivering the crypto asset to its users.
Requirements for crypto trading platforms
The OSC’s most recent news release reminds crypto trading platforms that the CSA is expanding existing requirements for Platforms operating in Canada. On August 15, 2022, the CSA announced that it expected unregistered Platforms to make commitments in the form of a pre-registration undertaking (PRU) to their principal regulator.
A PRU includes terms and conditions consistent with requirements currently applicable to registered Platforms, such as the requirement for an appropriate custodian to hold Canadian clients’ assets. Appropriate custodians are those that are regulated by a financial regulator in Canada, the U.S., or a similar jurisdiction with a supervisory regime for conduct and financial regulation. Further, Canadian clients’ assets must be segregated from the Platform’s proprietary business. The Platforms are also prohibited from offering margins or leverage to any Canadian client.
If a Platform does not deliver a PRU to its principal regulator or otherwise cease operating, the CSA will consider all applicable regulatory options to bring the platform into compliance with securities law, including enforcement action. Importantly, the CSA will consider Platforms located outside of Canada that are accessible by Canadians as operating in Canada for the purposes of securities regulation.
Although the CSA has yet to announce the deadline by which PRUs must be delivered, it is something Platforms should be mindful of and consider taking steps to bring themselves into compliance with sooner rather than later.
Crypto trading Platforms that are registered or that have entered into a PRU are prohibited from permitting Canadian clients to trade, or obtain exposure to, any crypto asset that is itself a security and/or a derivative. Platforms should therefore have established policies and procedures to determine whether each crypto asset they provide exposure to is a security and/or derivative. Registered Platforms are subject to terms and conditions which may vary depending on the Platform’s characteristics. For example, Coinsquare Capital Markets Ltd. is a registered crypto asset trading platform and is permitted to engage in the business of trading Crypto Contracts in relation to Crypto Assets. It is prohibited from offering derivatives based on Crypto Assets other than Crypto Contracts.
Recent OSC Enforcement Action Relating to Crypto
In line with this trend of expanding regulation, the OSC has recently commenced enforcement proceedings against several entities for operating unregistered crypto asset trading Platforms accessible by Ontario residents. The proceedings focus on Platforms that maintain custody of crypto assets deposited and traded on the Platform in wallets, meaning investors rely upon their contracts with the Platform to obtain possession of the crypto assets in their accounts. The OSC characterized these contracts as constituting securities and/or derivatives.
For example, in August 2021, the OSC commenced enforcement proceedings against Seychelles-based Aux Cayes Fintech Co. Ltd. (Aux Cayes), the operator of the OKX platform, for breaching the registration and prospectus requirements under Ontario securities law.
In a recent settlement agreement, Aux Cayes agreed to sanctions consisting of disgorgement of total revenues of approximately $514,950 USD earned from Ontario investors, a fine of $600,000 CAD and costs of $25,000 CAD. Aux Cayes admitted that it operated the OKX platform through which Ontario investors could trade securities and derivatives based on exposure to underlying assets that included crypto assets as an unregistered dealer of securities in contravention of the Securities Act. It was a mitigating factor that Aux Cayes took steps to prevent Ontario investors from opening new accounts or making deposits in existing accounts one month after it was contacted by the OSC. Aux Cayes also undertook to restrict its Ontario business while pursuing registration and to wind down its Ontario operations should registration not be feasible.
Enforcement action in the U.S.
Similar trends are also taking place in the U.S. For example, there have been 97 crypto-currency related enforcement actions between July 2013 and 2021, 20 of which were brought in 2021 alone. The SEC’s actions have focused on fraud and unregistered securities offerings.
The SEC has also increased its resources devoted to the digital asset space. In the first half of 2022, it nearly doubled the size of its Crypto Assets and Cyber Unit while an Office of Crypto Assets was created within the Disclosure Review Program. In addition, market intermediaries such as exchanges and broker-dealers face increased scrutiny by the SEC.
The OSC and SEC have ramped up their enforcement actions in the cryptocurrency space. This firmer approach to cryptocurrency regulation will likely continue in 2023 as cryptocurrency offerings continue to grow. It is crucial that cryptocurrency platforms understand what obligations apply under the applicable securities legislation.
 A “Crypto Contract” is the investor’s contractual right to a crypto asset which may itself constitute a security and/or a derivative. A “Crypto Asset” refers to anything commonly considered to be a crypto asset, digital or virtual currency, or digital or virtual token (such as Bitcoin or Ether) that are not themselves securities or derivatives
The author would like to thank the contributions of Brian Wood.