B.C. Securities Commission investigating two cryptoasset trading platforms

On November 4, 2019, the British Columbia Securities Commission (BCSC) publicly disclosed ongoing investigations into two cryptoasset trading platforms: Einstein Exchange and ezBtc. The BCSC also obtained an order from the B.C. Supreme Court appointing an interim receiver for one of these platforms. This is the first time a Canadian securities regulator has taken public enforcement action against a cryptoasset trading platform. The BCSC’s actions suggest that Canadian securities regulators will be more assertive in response to customer complaints concerning online platforms that deal in cryptoassets, even though the jurisdiction of securities regulators over these platforms remains unclear.

The investigations

Einstein Exchange is a cryptoasset trading platform operating in Vancouver, British Columbia, offering markets for a variety of cryptoassets. On November 1, 2019, the BCSC obtained a court order under the B.C. Securities Act appointing a receiver to take possession of the property of Einstein Exchange and affiliates. According to the affidavit sworn by a BCSC investigator in support of the receivership order, the BCSC commenced an investigation into Einstein Exchange in May 2019, after receiving complaints that requests to access assets held with Einstein Exchange were not being honoured. The affidavit also revealed that the BCSC had received complaints alleging improper use of funds and money laundering.

In early October 2019, the BCSC demanded that Einstein Exchange disclose financial information, including information on fiat currency (CAD and USD) and cryptoasset balances, which Einstein Exchange did not disclose. On October 31, 2019, Einstein Exchange’s lawyer informed the BCSC that a potential sale of the platform had fallen through, the platform  would be shutting down within 30 to 60 days, and Einstein Exchange had sufficient assets to satisfy customer withdrawals. The BCSC demanded information on Einstein Exchange’s fiat and cryptoasset reserves. Two hours later, Einstein Exchange’s lawyer withdrew from representation, and Einstein Exchange did not otherwise provide the information demanded by the BCSC. Records reviewed by the investigators showed that as of September 2019, Einstein owed customers a total of about C$16 million. The BCSC investigator attested to his belief that there was misuse of funds and that Einstein Exchange has a deficit in both its fiat currency and cryptoasset holdings.

The BCSC then brought a receivership application without notice to Einstein Exchange, which the B.C. Supreme Court granted. The BCSC relied upon provisions of the B.C. Securities Act authorizing the appointment of a receiver over a person’s property where the court is satisfied that the appointment is in the best interests of creditors, security holders or other persons whose property is in the possession or control of the person.

ezBtc was another cryptoasset trading platform operating from British Columbia. ezBtc is the defendant in numerous claims pending before the British Columbia courts and has ceased operating. According to a media report, on November 4, 2019, BCSC confirmed the existence of an investigation into ezBtc following customer complaints. Although it is unusual for securities regulators to confirm the existence of ongoing investigations, the BCSC did so, having “determined it is in the public interest to do so in this case.”

Implications

The receivership order involving Einstein Exchange is the first public enforcement action that a Canadian securities regulator has taken against a Canadian cryptoasset trading platform. Likewise, the BCSC’s investigations into Einstein Exchange and ezBtc are among the first publicly disclosed investigations by Canadian securities regulators into cryptoasset trading platforms. The only other publicly disclosed investigation is an investigation by the Ontario Securities Commission (OSC)  into the QuadrigaCX cryptoasset trading platform, which filed for court protection in February 2019.

Canadian securities regulators’ jurisdiction over cryptoasset trading platforms remains uncertain. Canadian regulators stated in CSA Staff Notice 46-307 Cryptocurrency Offerings that any cryptoasset trading platform “that offers cryptocurrencies that are securities must determine whether it is a marketplace”, in which case the platform is subject to the rules governing exchanges or alternative trading systems. However, Staff Notice 46-307 and the subsequent CSA Staff Notice 46-308 Securities Law Implications for Offerings of Tokens acknowledged that transactions involving cryptoassets may or may not involve transactions in securities, depending on the circumstances.

In March 2019, the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) published a discussion paper proposing a regulatory framework for platforms that trade cryptoassets. In the paper, CSA/IIROC acknowledged that cryptoassets that function as a form of payment or means of exchange on a decentralized network, such as bitcoin, are not in and of themselves, securities or derivatives. However, the paper proposed to apply securities legislation to platforms that offer trading in these cryptoassets where the legal arrangement between the platform and its users may itself be a security or derivative.

The paper suggested that securities regulators may take the position that where a cryptoasset trading platform customer does not take delivery of cryptoassets purchased on the platform (i.e., the platform retains control), the platform pools cryptoassets of all participants in common wallets and/or the platform may make use of the cryptoassets it holds for its users, that is evidence of a contract that is a security or derivative.

In the case of Einstein Exchange, the affidavit of the BCSC investigator stated: “In the view of BCSC staff, the trading platform operated by [Einstein Exchange] involves trading in securities.” The affidavit did not elaborate on whether BCSC staff considered some or all of the tokens traded on Einstein Exchange to be securities, or whether staff viewed the legal arrangement between Einstein Exchange and its customers to be a security or derivative. The specific basis for the BCSC to assert that the B.C. Securities Act applied to Einstein Exchange’s activities therefore remains to seen.

The ongoing investigations into cryptoasset trading platforms suggest that Canadian securities regulators are increasingly willing to exercise powers available to them under provincial securities laws with respect to these platforms. In the event of customer complaints or other concerns regarding safeguarding or use of customer cryptoassets, operators of Canadian cryptoasset trading platforms and other Canadian platforms dealing in cryptoassets can expect to receive regulatory inquiries and potentially be subject to investigations. Where regulators have reason to believe that customer assets, including cryptoassets, are at risk, regulators may take steps to protect investors by, among other potential remedies, asking the courts to appoint a receiver.

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Editors

Lawrence E. Ritchie

Partner, Litigation

Alexander Cobb

Partner, Litigation

Shawn Irving

Partner, Litigation

Kevin O’Brien

Partner, Litigation

Lauren Tomasich

Partner, Litigation

Lia Bruschetta

Associate, Litigation