Post by alanbond on Jun 8, 2021 23:15:30 GMT 4
Canadian regulators have escalated their confrontation with unregistered Crypto-Platforms.1 On May 25, 2021, the OSC issued a Notice of Hearing and Statement of Allegations2 accusing Polo Digital Assets, Ltd., a Crypto-Platform operating under the name Poloniex, of registration and disclosure violations.
The confrontation is unsurprising to those reading the regulatory tea leaves. In a press release issued March 29, 2021, the OSC warned unregistered Crypto-Platforms that they must commence regulatory discussions by April 19, 2021 or face possible enforcement action. The OSC's position is consistent with broader regulatory guidance announced in CSA's Staff Notice 21-329 3, which put Crypto-Platforms on notice that they were expected to fully integrate into the Canadian regulatory structure. Poloniex did not comply.4
Unregistered Crypto-Platforms pose risks of financial loss to investors due to platform insolvency, security breaches and fraud.5 Two massive Crypto-Platforms collapses - Mt. Gox and Quadriga (see this Siskinds post about the latter) - left Canadian investors with hundreds of millions of dollars in unrecoverable losses. Rather than ban Crypto-Platforms outright, Canadian regulators have opted to try to bring them into compliance.
The selection of Poloniex as a test case is curious, considering it is not ranked among the largest Crypto-Platforms. By most metrics - number of clients, daily trading volume or revenue - Poloniex is a little fish. The possible motivation could be two-fold: First, some of the larger and more established exchanges may be actively engaging with regulators, which would obviously obviate the need for an enforcement action. Indeed, the OSC stated in a press release that "more than 70 platforms have initiated compliance discussions with Canadian securities regulators". Second, Poloniex enforcement proceedings may have been chosen to serve a "bellwether" in preparation for more complex actions against bigger recalcitrant Crypto-Platforms. This is supported by the Statement of Allegations against Poloniex, which expressly states that one purpose of the enforcement action was "to signal that crypto asset trading platforms flouting Ontario securities law will face regulatory action".
Claims in the statement of allegations
By issuing a Statement of Allegations, the OSC has indicated that the findings of their preliminary investigation into Poloniex are serious enough to merit proceeding to a hearing.
The Statement of Allegations describes violations of two cornerstones of Ontario securities laws: Registration and disclosure. Poloniex is accused of engaging in the business of trading in securities without the necessary registrations (or exemptions). Poloniex is also accused of trading in securities which constitute distributions without complying with prospectus requirements (or exemptions).6
The OSC alleges that Poloniex permits the purchase and sale of Crypto Assets such as Bitcoin and Ethereum which are not immediately delivered to the client's wallet such that Poloniex investors "do not have possession or control of crypto assets deposited or traded on the Poloniex Platform".7 According to CSA guidance, such trading activity would subject an exchange to Canadian securities regulation. This is because without immediate delivery, investors remain vulnerable to insolvency risk, fraud risk, performance risk and proficiency risk on the part of the Crypto-Platform.8 Poloniex also allows investors to purchase Crypto Asset futures, which the OSC notes constitute securities and derivatives.9
Enforcement Staff seek a number of remedies, including a cease trade order, prohibition on acquiring securities, administrative penalties of $1 million per compliance failure, disgorgement of profits and other relief.10
Enforcement challenges for the OSC
If the action proceeds to a hearing, the OSC may face two challenges.
First, there may be jurisdictional challenges. Poloniex is based in the Seychelles, a former French colony and archipelagic island east of mainland Africa.11 However, the OSC has jurisdiction over exchanges with a "real and substantial connection" to Ontario and it is likely that Poloniex would satisfy the test.12 Even without a physical office in Toronto, internationally-based exchanges may have a "real and substantial connection" if they promote or offer their services to Ontario investors. The Statement of Allegations notes that "[t]he Poloniex Platform is available to Ontario residents", "Poloniex encourages Canadians to use the Poloniex Platform" and that "Canada is also not identified in the list of "Restricted Territories" on Poloniex's website".13 This suggests a strong case for jurisdiction.
Second, there may be compliance issues. If the OSC is successful, it may find that any fines, penalties or cease trade orders that are issued are toothless. This is due to the decentralized, pseudonymous and digital nature of Crypto Assets, which means that any Crypto Assets held by the exchange will not be found in a physical bank vault that a third-party controls (for example). Recovery will be entirely dependent on the cooperation of the Crypto-Platform management personnel holding the keys to the relevant wallets. It is extremely easy for uncooperative exchanges to shift assets far from the reach of regulators and investors, as the Quadriga collapse showed.
Another issue is administering non-monetary penalties (such as injunctions) against a foreign Crypto-Platform that is physically outside the reach of the Canadian legal system Enforcing injunctions like cease-trade orders will likely require assistance from the Seychelles Financial Services Authority. The Seychellois authorities have assisted with international actions against its Crypto-Platforms, such as the American crackdown against Bitmex for anti-money laundering violations.
Whether the OSC's enforcement proceeding is successful remains to be seen, as the allegations remain unproven.
Footnotes
1 Crypto-platforms are entities that facilitate transactions relating to crypto assets (such as bitcoin), including buying and selling crypto assets.
2 OSC Statement of Allegations In the Matter of Polo Digital Assets Ltd. dated May 25, 2021 ("Statement of Allegations").
3 CSA Staff Notice 21-329, Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements, issued March 29, 2021.
4 Statement of Allegations at para 6.
5 CSA Staff Notice 21-327, Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets, issued January 16, 2020.
6 Statement of Allegations at paras 17-18.
7 Statement of Allegations at para 11.
8 CSA Staff Notice 21-327, Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets, issued January 15, 2020.
9 Statement of Allegations at para 12.
10 Statement of Allegations at paras 20-28.
11 Statement of Allegations at para 8.
12 Ontario Securities Commission v. DaSilva, 2017 ONSC 4576.
13 Statement of Allegations at paras 2, 16
The confrontation is unsurprising to those reading the regulatory tea leaves. In a press release issued March 29, 2021, the OSC warned unregistered Crypto-Platforms that they must commence regulatory discussions by April 19, 2021 or face possible enforcement action. The OSC's position is consistent with broader regulatory guidance announced in CSA's Staff Notice 21-329 3, which put Crypto-Platforms on notice that they were expected to fully integrate into the Canadian regulatory structure. Poloniex did not comply.4
Unregistered Crypto-Platforms pose risks of financial loss to investors due to platform insolvency, security breaches and fraud.5 Two massive Crypto-Platforms collapses - Mt. Gox and Quadriga (see this Siskinds post about the latter) - left Canadian investors with hundreds of millions of dollars in unrecoverable losses. Rather than ban Crypto-Platforms outright, Canadian regulators have opted to try to bring them into compliance.
The selection of Poloniex as a test case is curious, considering it is not ranked among the largest Crypto-Platforms. By most metrics - number of clients, daily trading volume or revenue - Poloniex is a little fish. The possible motivation could be two-fold: First, some of the larger and more established exchanges may be actively engaging with regulators, which would obviously obviate the need for an enforcement action. Indeed, the OSC stated in a press release that "more than 70 platforms have initiated compliance discussions with Canadian securities regulators". Second, Poloniex enforcement proceedings may have been chosen to serve a "bellwether" in preparation for more complex actions against bigger recalcitrant Crypto-Platforms. This is supported by the Statement of Allegations against Poloniex, which expressly states that one purpose of the enforcement action was "to signal that crypto asset trading platforms flouting Ontario securities law will face regulatory action".
Claims in the statement of allegations
By issuing a Statement of Allegations, the OSC has indicated that the findings of their preliminary investigation into Poloniex are serious enough to merit proceeding to a hearing.
The Statement of Allegations describes violations of two cornerstones of Ontario securities laws: Registration and disclosure. Poloniex is accused of engaging in the business of trading in securities without the necessary registrations (or exemptions). Poloniex is also accused of trading in securities which constitute distributions without complying with prospectus requirements (or exemptions).6
The OSC alleges that Poloniex permits the purchase and sale of Crypto Assets such as Bitcoin and Ethereum which are not immediately delivered to the client's wallet such that Poloniex investors "do not have possession or control of crypto assets deposited or traded on the Poloniex Platform".7 According to CSA guidance, such trading activity would subject an exchange to Canadian securities regulation. This is because without immediate delivery, investors remain vulnerable to insolvency risk, fraud risk, performance risk and proficiency risk on the part of the Crypto-Platform.8 Poloniex also allows investors to purchase Crypto Asset futures, which the OSC notes constitute securities and derivatives.9
Enforcement Staff seek a number of remedies, including a cease trade order, prohibition on acquiring securities, administrative penalties of $1 million per compliance failure, disgorgement of profits and other relief.10
Enforcement challenges for the OSC
If the action proceeds to a hearing, the OSC may face two challenges.
First, there may be jurisdictional challenges. Poloniex is based in the Seychelles, a former French colony and archipelagic island east of mainland Africa.11 However, the OSC has jurisdiction over exchanges with a "real and substantial connection" to Ontario and it is likely that Poloniex would satisfy the test.12 Even without a physical office in Toronto, internationally-based exchanges may have a "real and substantial connection" if they promote or offer their services to Ontario investors. The Statement of Allegations notes that "[t]he Poloniex Platform is available to Ontario residents", "Poloniex encourages Canadians to use the Poloniex Platform" and that "Canada is also not identified in the list of "Restricted Territories" on Poloniex's website".13 This suggests a strong case for jurisdiction.
Second, there may be compliance issues. If the OSC is successful, it may find that any fines, penalties or cease trade orders that are issued are toothless. This is due to the decentralized, pseudonymous and digital nature of Crypto Assets, which means that any Crypto Assets held by the exchange will not be found in a physical bank vault that a third-party controls (for example). Recovery will be entirely dependent on the cooperation of the Crypto-Platform management personnel holding the keys to the relevant wallets. It is extremely easy for uncooperative exchanges to shift assets far from the reach of regulators and investors, as the Quadriga collapse showed.
Another issue is administering non-monetary penalties (such as injunctions) against a foreign Crypto-Platform that is physically outside the reach of the Canadian legal system Enforcing injunctions like cease-trade orders will likely require assistance from the Seychelles Financial Services Authority. The Seychellois authorities have assisted with international actions against its Crypto-Platforms, such as the American crackdown against Bitmex for anti-money laundering violations.
Whether the OSC's enforcement proceeding is successful remains to be seen, as the allegations remain unproven.
Footnotes
1 Crypto-platforms are entities that facilitate transactions relating to crypto assets (such as bitcoin), including buying and selling crypto assets.
2 OSC Statement of Allegations In the Matter of Polo Digital Assets Ltd. dated May 25, 2021 ("Statement of Allegations").
3 CSA Staff Notice 21-329, Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements, issued March 29, 2021.
4 Statement of Allegations at para 6.
5 CSA Staff Notice 21-327, Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets, issued January 16, 2020.
6 Statement of Allegations at paras 17-18.
7 Statement of Allegations at para 11.
8 CSA Staff Notice 21-327, Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets, issued January 15, 2020.
9 Statement of Allegations at para 12.
10 Statement of Allegations at paras 20-28.
11 Statement of Allegations at para 8.
12 Ontario Securities Commission v. DaSilva, 2017 ONSC 4576.
13 Statement of Allegations at paras 2, 16