On July 26, 2024, the Registration, Inspections and Examinations Division of the Ontario Securities Commission (OSC) published its annual OSC Staff Notice 33-756 – Summary Report for Dealers, Advisers and Investment Fund Managers (SN 33-756).
SN 33-756 provides guidance on compliance and registration requirements for registrants, with a particular focus on newly registered firms which are considered high-risk, including crypto asset trading platforms (CTPs).
The Report provides the following guidance specific for CTPs.
Registration Applications
Registration applications for CTPs should be as complete and comprehensive as possible, including detailed information regarding know your client and account appropriateness assessment, know your product, conflicts of interest and custody.
Immediate Delivery of Crypto Assets
SN 33-756 provides guidance regarding what constitutes "immediate delivery" in respect of claims from some firms they are not subject to securities legislation in Canada:
- (i) the platform immediately transfers ownership, possession, and control of the crypto asset to the platform's user, and the user is free to use, or otherwise deal with, the crypto asset without further involvement with or reliance on the firm or its affiliates, and without the firm or any affiliate retaining any security interest or any other legal right to the crypto asset; and
- (ii) following the immediate delivery of the crypto asset, the platform's user is not exposed to insolvency risk (credit risk), fraud risk, performance risk or proficiency risk on the part of the firm.
In particular, the OSC notes that when a platform offers wallet functionality developed by it or an affiliate, it is unlikely to not result in immediate delivery as the wallet software or hardware likely exposes users to the risks noted in (ii) above, as users do not have sole ownership, possession and control of the wallet. It is unclear from this comment whether the OSC is referencing non-custodial, open source wallet software that resides solely on a user's device and does not give the software provider access to the crypto assets of the wallet's user. Such wallet software would not expose users to the risks noted in (ii) above.
The OSC also rejects claims made by some firms that they are not subject to securities legislation because they provide payment services by facilitating users, "sending a crypto asset, including value-referenced crypto asset (commonly known as stablecoins), to the platform solely to have the crypto asset converted into fiat". It is unclear which part of this business model fails to meet the OSC's criteria for "immediate delivery" in circumstances where the stablecoins are immediately converted into fiat which is then sent promptly to the user.
The OSC enumerates the following factors for consideration when assessing whether immediate delivery of crypto assets is provided to platform users:
- how long a typical transaction would take;
- when trades would be posted to the blockchain;
- how long the platform or the firm's affiliate would hold onto client assets, including crypto assets and fiat;
- following the confirmation or trade, how long it would take for the platform to send the crypto assets to the client's wallet address;
- percentage of transactions where immediate delivery is made on the platform; and
- how the firm ensures it has sufficient crypto asset and fiat currency balances in its inventory to fill client trades.
Marketing of CTPs
The OSC notes the following concerns regarding advertisement and social media practices of CTPs:
- misleading, incorrect, or false statements and unsubstantiated claims involving ranks or providing comparison with other CTPs;
- usage of the OSC's logo in marketing, which is prohibited;
- improper "gambling style" promotions and schemes which involve encouraging trades to win contests, making statements in social media which imply purchasing or holding a particular crypto asset, or encouraging users to trade quickly for fear of missing out. These activities designed to encourage trading may be considered a form of solicitation and trigger suitability obligation, from which many CTPs are exempt pursuant to the terms and conditions of their registration.
SN 33-756 recommends that CTPs (i) only make accurate statements in advertisements that can be substantiated, (ii) provide adequate context and reference to the information supporting advertising claims, including third-party identification of sources, (iii) refrain from including regulator logos in marketing materials, (iv) obtain written authorization from other registrants if the firm chooses to use the name of another registrant, and (v) avoid "gambling style" promotions and schemes.
Conflicts of Interest
The OSC notes instances in which CTPs did not properly identify material conflicts of interest (including those reasonably foreseeable) and failed to disclose and address certain material conflicts in the best interest of the client, including the following:
- outside business activities, such as any involvement with a crypto asset issuer or development;
- employee personal trading activities and use of proprietary and confidential information;
- referral arrangements with other service providers or affiliates;
- fees or compensation earned from buying and selling of crypto assets, including crypto assets held by the CTP as its inventory for resale (as counterparty);
- relationships with related entities, particularly those also involved in the distribution (trading) or handling of crypto assets;
- issuance and trading in proprietary crypto assets or related/connected issuer crypto assets;
- handling of airdrops derived from client asset holdings held in trust on behalf of clients; and
- pricing of crypto assets on platform, including any fees and spreads earned on trades.
The OSC recommends that CTPs: (i) identify material conflicts of interest, including those reasonably foreseeable, (ii) develop policies and procedures and internal controls to address in the best interests of clients, (iii) maintain records to demonstrate the CTP's assessment of conflicts of interest, (iv) provide adequate training to employees, and (v) provide prompt and sufficient disclosure to clients.
Mandatory Arbitration Clauses
Some CTPs' terms of use restrict the client's ability to initiate legal suit and include mandatory arbitration clauses in a foreign jurisdiction. The Report notes that such clauses can be unenforceable as they are contrary to public policy and unconscionable and can also breach a registrant's obligation to deal fairly, honestly and in good faith with clients. Regardless of whether mandatory arbitration clauses are used, CTPs must make available dispute resolution services (i.e. with the Ombudsman for Banking Services and Investments ("OBSI"), which is a condition of registration for all CTPs).
CTPs obtaining CIRO membership
The Canadian Securities Administrators and CIRO recently issued a news release to remind CTPs currently registered as restricted dealers to prioritize their application for registration as investment dealers and membership with CIRO. The CSA also does not intend to continue with the interim approach for the time-limited restricted dealer registration for CTPs (see here for more information).
CTPs intending to apply for CIRO membership must review the Investment Dealer and Partially Consolidated Rules carefully before applying, as many will be new for restricted dealer CTPs, such as higher capital requirements, more prescriptive requirements for books and records systems, proper segregation and custody, the requirement to engage a CIRO approved auditor and different proficiency and experience requirements for registered individuals.
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