Ross McKee has been a securities lawyer for over 30 years and passionate about new technologies for just as long. Now, as a member of one of Canada’s largest law firms’ team, he tackles cryptosphere legal issues and helps blockchain businesses navigate the regulatory landscape in Canada.
Tell us a few words about yourself and about your firm’s background
Blake Cassels & Graydon is a classic large Canadian law firm. We’ve been around since the 1850s, we’re one of the largest law offices in Canada, and so we cover a range of things, such as banking regulations, security regulation, general commercial law and so on. We also have a program called Blakes Nitro which focuses on assisting startups and the legal questions that arise in a start-up business.
For me personally, I’ve been a securities lawyer for over 30 years, and I’ve been following technology since the introduction of things like the fax machine, the Internet, and now blockchain. My own personal interest in blockchain was stemmed somewhat unusually – I was an officer in the army reserve in Canada for many years, and at one point I was the unit’s codes officer, so I’ve always been interested in codes and cryptography, and when Bitcoin came along, I wasn’t particularly professionally interested, I just thought it was kind of a cool thing.
What is your firm’s involvement in blockchain projects and how did it first get into this space?
We first got involved in this through the money service side. Back around 2013, we did the regulatory analysis for the first Bitcoin ATM being set up in Canada. It came to one of our lawyers who works in financial services regulation, and she asked me whether I thought Bitcoin was a security. We did the legal analysis, around Bitcoin in particular, and I concluded that it wasn’t a security, and I’m glad the SEC and others have finally caught up to that.
Around 2016 we got more involved in the enterprise side of things. I’ve been involved with the Governance Professionals of Canada, which is basically corporate secretaries, focusing on the proxy process for public companies and there’s a constant problem with reconciling share ownership with votes, issues like over-voting and such. There was an interesting article from a Delaware Chancellor about whether blockchain could be the plunger for the proxy “plumbing” system. So, we’ve started learning more about Ethereum and so on. Then ICOs were just getting started at the very end of 2016 and when the whole ICO-tsunami of 2017 came, it’s something we got involved in as well.
How active are the Canadian legislators when it comes to the cryptoasset space?
I think Canada is very active in virtually every aspect of it. Toronto, in particular, has been rather a prominent node for blockchain in general, in both research and development. For example, it is famous as being the place where Ethereum got started and then moved to Switzerland for organizational purposes. We are currently active in all the areas of ICOs, STOs, companies like Polymath that had been the standard-bearers for the STOs are based in Toronto. Canada has had crypto-investment funds on the private side for some time, and they’ve been regulated; we’ve got some major exchanges like Coinsquare in Toronto. So, the business is active and the regulators are active as well.
Are there any specific kinds of blockchain projects that Canada should be considered the jurisdiction of choice for?
On the cryptoassets side of things, the growing area of security token offerings is going to be of great interest. That’s because while Canada is heavily regulated, it’s also relatively rules-based. You have a system which says “If you satisfy these particular requirements, then you can do that,” and that’s the kind of regulatory system that fits with STOs, In some ways, it’s not entirely left to the discretion of regulators, there’s a fairly robust rule system.
Canada is using an exemptions system instead of a no-action system; you can actually apply to regulators in Canada to get a specific, crystal-clear discretionary exemption from the rules saying “Your project does not need to comply with these particular rules for these particular reasons and on these particular conditions.” There is a regulatory sandbox where there are many projects that are applying for these exemptions, including some that I’m working on. We haven’t had a great many of those coming through, but at least the regulators are open and there’s a system that makes that kind of a regulatory relief available. That provides a great advantage of regulatory certainty, as opposed to just having to rely on lawyers interpreting things and then having to persuade buyers that interpretation is valid or not too risky, etc.
We haven’t had crypto public offerings yet, but there are some merchant bank-type companies listed on Canadian exchanges, such as Galaxy Digital, that are involved in the area – though they’re not actually directly issuing crypto but are investing in crypto-related projects.
What’s your take on the shift from ICOs to STOs? Do you think this is a positive development?
I think it’s a very positive development. I think ICOs have been problematic for many reasons, not the least of which is that they created an image that it was a bit of a Wild West situation in the crypto sphere. I remember, when I first started hearing about ICOs, I was thinking that I was a terrible securities lawyer, because I couldn’t think of how they were doing these offerings legally! I thought that there must be some exemption that I’m not smart enough to think of, that would apply to these. But gradually I came to realize that, in fact, there was no exemption at all, and that many of these ICOs, if not most of them, were clearly securities. And they were entirely unregulated, on the basis that some people thought it was a new thing and that the rules didn’t apply. That’s like people selling stuff over the internet and thinking “Because I can sell it on the Internet, that means that no rules apply,” and we all know that’s no longer the case.
STOs are a more mature development in that they recognize that laws do apply. They are taking the advantages blockchain technology has for the speed and certainty of execution, and applying them to a huge trillion-dollar industry of trading investments. It’s replicating an industry that’s there, but applying new technology to it.
Is there a difference in the legal approach to cryptoassets between Canada and the US?
There are more similarities than differences. In the leading case about what is the definition of an investment contract, the Supreme Court of Canada had adopted many of the US common law tests for investment contracts, the famous Howey case, and others. So, the US tests for when an investment contract is considered a security are largely similar to the legal tests used in Canada. Canada’s common law is heavily influenced by the US common law in that regard, so I would say that, in global terms, the US and Canada are very similar in how they interpret whether something is a security or not. The approach is a little bit different beyond that because we don’t have a separate commodity trading regulator, such as the CFTC in the US. In Canada, it tends to be lumped under the same regulator.
If you take those similarities into accounts, would you say that the US’s proximity is an advantage or inconvenience when creating a friendly legal environment for cryptoassets in Canada?
Canadian regulators are conservative and Canadian securities regulators would look to the SEC and would want to have at least the interpretations lined up. So, you’re going to find the SEC interpretations being largely followed by the Canadian regulators, although not entirely lockstep. The policy issues around it may differ, and so we may come up with rulemaking in Canada that ends up with exemptions that are different than in the United States, but not hugely different, because regulators recognize that trading goes back and forth across the border, the markets are interlinked in many ways. I do think that Canada is prepared to come up with rules and policies that are not just mimicking the United States, but you’re not going to find a drastically different approach on fundamental principles.
The Canadian Securities Administrators together with the Investment Industry Regulatory Organization of Canada has recently released a consultation paper on cryptoassets. I’d like to hear your comments on this document.
Briefly, for those who aren’t familiar with the topic – The Canadian Securities Administrators (CSA) is a collective name for all of the Canadian provincial securities regulators. We don’t have a federal securities regulator in Canada, it’s based on provincial and territorial regulators, so this is technically 13 jurisdictions, but they try to be as uniform as possible. And so, the CSA is the organization through which they work and they try to come up with so-called “national instruments” that are basically harmonized rules across the country. And then the Investment Industry Regulatory Organization of Canada (IIROC) is essentially the Canadian market regulator; it’s a very close equivalent of FINRA in the United States, which regulates both broker dealers, who are called investment dealers in Canada, and also the markets.
The first comment that I have is that it’s very good that they came together in joint consultation. You’ve got the securities regulators and market regulators working together on this. And the second thing of interest is that it is, in fact, a consultation paper. The last two times that the CSA talked about cryptoassets and ICOs, they just dropped a staff notice on the industry saying “Here’s what we think” and there was no opportunity to discuss with them whether their interpretations were valid or correct or practical. But this time around, they are taking a different approach and they came up with questions saying “Here are our preliminary thoughts and we’d be interested in consulting with you as to whether you think we have this right and whether there are other factors we should think about.” And what they’re really focusing on is market infrastructure, not so much ICOs or token offerings. It’s a market-related consultation paper, so it’s about exchanges and marketplaces and trading platforms for cryptoassets, so it would include STOs and others, not necessarily just tokens or ICOs, etc.
In Canada, there is a system for regulated marketplaces. A marketplace brings together multiple buyers and sellers, and then, through algorithms or matching systems, the orders interact with each other automatically. So, the buyer and seller don’t get to pick who is on the other side of their trade, the marketplace itself, through time and priority and pricing rules, determines how that trade gets executed. In the cryptoasset area, there are marketplaces where you just put in an order and the system, whether it’s decentralized or centralized, figures out the rest. Now the regulators are trying to figure out whether these should be regulated in a similar way to traditional markets, what aspects of traditional marketplace regulation are necessary and are there new types of regulations they should be thinking about for these new types of assets.
What would your feedback be for the regulators with regards to this consultation paper?
I’d look at it from a broader perspective, I would tell the regulators – Look, we’ve been consumed over the last couple of years with the question of whether a token is a security or not. And if it is a security, then we bring the full rigor of the law to the distribution rules around ICOs and STOs, to dealer regulation, to the regulation of custody, to marketplace regulation and so on. On the other hand, if the existing regulatory definition of a security doesn’t fully apply, then there is no regulation for such a token. And that kind of black/white distinction hasn’t been helpful. I would, for example, take the national embarrassment of Quadriga CX, the Canadian exchange that turns out to have been run off a single laptop. The problem there was that if that exchange was not trading securities, then it didn’t fall within the jurisdiction of the securities regulators. Perhaps what they ought to have done and still could do, would be to say that they need to regulate this general area of tokens in some fashion, beyond mere securities, but not necessarily bring the full rigor of securities law into it. They should recognize that some of these tokens may not necessarily be traditional securities, and some of the policy reasons behind those regulations may not apply. But on the other hand, it certainly is financial and it certainly is people’s financial well-being that is at risk, and so, perhaps, there should be a lighter touch of broader regulation combined, so it won’t be the full stock exchange regulation, but a more basic one; things like a registration requirement, or a requirement to have a trust company involved in holding funds in some fashion, or criminal record checks, or a requirement to file a business continuity plan with the regulator, things like that. The way they regulate it now is that it’s either “all or nothing”, and the “nothing” has been a problem. Plus, there isn’t really a regulator to deal with that area right now, because the securities ones are focusing on assets that they determined to be securities, and therefore they’re leaving alone the assets that they determined not to be securities or which they can’t prove are securities.
With respect to securities regulation itself, the regulators need to be careful in applying all the rules to these new marketplaces, regardless of the nature of the business and the nature of blockchain in particular. For example, the consultation paper talks about settlement and clearing agencies and whether these are required, but with blockchain transactions, in most cases, the transaction is both the settlement and the clearing, all at the same time. And so, they don’t need to necessarily have a clearing agency dealing with trades two or three days after the trade’s been made, the way traditional exchanges work now. So, they’re going to have to adapt some of their rules to reflect the actual nature of blockchain type transactions.
It does come down to the balance between regulatory certainty and encouraging innovation, doesn’t it?
Absolutely, and it’s a difficult balance. We have this regulatory sandbox in Canada where they’re trying to say that they are encouraging innovation, but much of that “encouragement” is more a matter of saying “here are all the laws that apply to that innovation, so you better comply with all of them.” Fundamentally, they are in the investor protection business. That is something that the creators of these token projects need to remember – they should also be in their customer protection business, and they can come up with alternatives to traditional rules that give people the equivalent protection. They can, for example, say that they don’t need regulatory protection, because the protection is baked into their system in some fashion. But they have to recognize where the regulators are coming from.
What information should somebody wishing to get involved in the cryptosphere in Canada be seeking to begin with?
First of all, and this is not a marketing pitch, they need to consult with security lawyers, just to understand the Canadian system. Some people assume that the US rules apply in Canada because some of the terminology is similar. For example, we have an accredited investor exemption and the United States has an accredited investor exemption, but the mechanics around these exemptions are different.
Once you’ve figured out what type of category you’re dealing with, in terms of the issuer and whom you’re selling to, then the rules are pretty clear. Well, on the distribution side of things, we are still not entirely clear yet on the rules that would apply to intermediaries involved, and that’s something that this consultation paper is seeking to provide some guidance for. But generally speaking, when issuers are doing their own thing directly with the investors directly, those sorts of issues typically won’t arise.
What is your personal perspective on the opportunities that a wider blockchain adoption brings to lawyers such as yourself?
I personally found it fascinating and highly intriguing, because, in many ways, it brought me back to some of the fundamentals, to questions like “what is being regulated?”, “why is it being regulated?”, “what are the important parts of this that are being regulated and what’s the reason and basis for that?” And it challenges some of the assumptions, like accredited investors for example – is it right and proper that people who have high net worth or high asset values are the ones who get special access to these deals, versus people who don’t necessarily get into that. So that’s been a really engaging and interesting work.
And then, as the market infrastructure is being built out, getting to know some aspects of that and thinking about how those things apply, it’s been fascinating legal work. I think it is a huge burgeoning wave that we’re having, as this is going to become the way we’re going to be transacting in many assets going forward. In some cases, of course, it’s not appropriate – it’s doing blockchain for the sake of doing blockchain, as opposed to doing it because it makes great sense. But as we work out the use cases, there’s a huge opportunity for this, and companies who are leading in this area are going to have a great benefit going forward.