Crypto-currency trading platforms ("Crypto-Platforms") received an unwelcome surprise last month, when eleven of them were hit with coordinated class action suits in America by two law firms. The class actions target some of the largest crypto-currency exchanges in the world: Binance, Bibox and KuCoin, along with several individual defendants.

Crypto-Platforms are online trading platforms that generally allow investors to (1) purchase and sell Bitcoin and other crypto-currency using fiat currency; (2) store their crypto-currency in online "Digital wallets"; and (3) participate in initial coin offerings ("ICOs") investing in the development of new tokens. 

The American class actions were filed on April 6, 2020 in federal court in the Southern District of New York, a popular venue for complex financial litigation. The proposed class is investors who purchased digital tokens on ICOs hosted on the defendants' online exchanges and lost much of their holdings when the tokens crashed.

The complaint against Binance, one of the targets, alleges that the Crypto-Platform based in Malta improperly hosted the sale of twelve digital tokens on its platform in return for listing fees (as well as a percentage of each trade). These digital tokens were sold in ICOs, which operate similar to IPOs as they can be used to raise capital from investors. The complaint alleges that "Binance and the Issuers entered into contracts to list these Tokens for sale on the Binance exchange in violation of federal and state law. As a result, Binance and the Issuers reaped billions of dollars in profits." While these digital tokens were classified as "utility tokens" (generally not considered securities in America), it was alleged that they were in substance "securities" because they were investments in speculative projects. Therefore, the issuers were subject to federal securities laws and should have filed registration statements with the SEC and Binance was required to register with the SEC as an exchange or broker-dealer. 

But Binance did not register as an exchange, nor did the token issuers provide adequate disclosures. All investors got were "whitepapers", informal disclosure documents with some information about their investments, but lacking the details of formal SEC securities disclosures. For example, the complaint alleges that the whitepapers lacked critical information about the significant risks inherent in the digital tokens, which led class members to make foolhardy investments. As a result, "Binance participated in illegal solicitations and sales of securities for which no registration statement was in effect, and as to which no exemption from registration was available." Rights of action include federal claims of unregistered offer and sale of securities, unregistered broker and dealer violations as well as state "blue sky" laws

The Binance case and its brethren are uncertified, so it remains to be seen how they fare. But the American legal landscape is often the canary in the coalmine, and similar cases could arise in Canada. The Canadian Securities Administrators ("CSA") warned in one of their staff notices that "Securities laws in Canada will apply if the person or company selling the securities is conducting business from within Canada or if there are Canadian investors."

To date, no cryptocurrency trading platform has been recognized as an exchange in any jurisdiction in Canada. However, several Crypto-Platforms actively solicit Canadian investors.

But Crypto-Platforms with Canadian customers should be cautious. As Siskinds discussed in an earlier post, the CSA places substance over form when deciding if a Crypto-Platform is subject to Canadian securities laws. In its January 16, 2020 guidance, the CSA indicated that Crypto-Platforms that act like exchanges will be treated as such (and subject to applicable regulations). Under the CSA's purposive approach, a Crypto-Platform that does not immediately deliver crypto-assets to customers as a typical commercial practice is likely subject to Canadian securities regulations. Crypto-Platforms which host ICOs that sell tokens whose value is tied to the future profits or success of a business would also be subject to Canadian securities regulations. 

Unfortunately, just because an entity calls itself an exchange, doesn't mean that it is complying with securities laws applicable to exchanges. This is the alleged core of the American crypto-exchange class actions against Binance and others: Entities that should have followed the rules, didn't, and investors lost big. The American experience should be a warning light for Canadian investors on Crypto-Platforms: Approach with caution.

Investors should consult with experienced securities lawyers to learn more about the risks and remedies associated with Crypto-Platforms.

Originally published 06 May 2020

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