As Canadian regulators take aim at ICOs, questions about enforceability arise

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As Canadian securities regulators enter the "uncharted waters" of initial coin offerings, questions are arising about how feasible it will be for the watchdogs to enforce investor protection laws – particularly on offshore companies.

The Canadian Securities Administrators published a staff notice this week aimed at clarifying its policy on ICOs, an emerging fundraising method in which companies sell digital "tokens" or "coins" to finance new ventures. ICOs, which in some cases are similar to crowdfunding, have garnered attention after some early-stage companies managed to raise tens of millions of dollars in minutes. Research firm Smith and Crown says that at the end of last month, $1.3-billion (U.S.) had been raised using this method.

In its notice, the CSA states that because each coin offering is unique, regulators will decide on a case-by-case basis whether it constitutes a security and is therefore subject to laws aimed at protecting investors. The notice also states that the rules apply not only to those operating from within Canada but also to offshore companies selling their tokens to Canadian investors.

Read more: Canadian regulators take on 'wild west' world of initial coin offerings (subscribers only)

However, industry insiders say it's unclear how regulators will enforce the rules on offshore entities, who may be operating behind a veil of anonymity. They also raise concerns that Canadian entrepreneurs could simply relocate their companies to places such as Switzerland, which some have dubbed "Crypto Valley" due to its high concentration of cryptocurrency startups.

"They might just disregard [the law] and go to another jurisdiction," says Iliana Oris Valiente, founder of ColliderX, a blockchain research and development hub. "The blockchain space is full of digital nomads."

Experts say Switzerland's low taxes and high degree of financial privacy make it attractive to ICO developers. For example, Ethereum, a blockchain-based computing platform often used to issue new ICOs, was started by Torontonians but launched through a Swiss non-profit foundation.

Pat Chaukos, who heads up an Ontario Securities Commission initiative aimed at helping fintech businesses, said Canadian regulators work with international regulatory bodies.

"We know that cryptocurrency and coin/token offerings are a trend globally and one that operates in relatively uncharted waters up to now," Ms. Chaukos said in a statement.

"While there may be companies in the digital arena who wish to remain anonymous, the CSA is committed to ensuring the protection of Canadian investors. We published this notice for businesses who want to raise capital in Canada, and within our regulatory framework. In terms of how rules will be enforced, while we understand this is a new and evolving space, we will apply the same regulatory lens and scrutiny we would for any other type of business."

In the past, regulators could rely on intermediaries such as financial institutions to help them enforce the law, says Moe Adham, co-founder of Ottawa-based Bitaccess Inc., which produces Bitcoin ATMs and other digital currency products. But that's more challenging in the blockchain space, where the only intermediaries are cryptocurrency exchanges, many of whom are also overseas.

Christine Duhaime, a Canadian lawyer and founder of the Digital Finance Institute, says it all comes down to whether the exchange in question is competent and playing by the rules of the financial system. If so, regulators can use a subpoena to obtain records. But if the exchange is irresponsible or operating out of a jurisdiction that serves as a tax haven or doesn't have strong anti-money-laundering laws, enforcement could be tricky, Ms. Duhaime says.

"There are a whole lot of irresponsible ICOs out there that will take money from anywhere and anybody, and that's the big issue for the exchanges as well as our financial regulators," she says.

Manoj Pundit, of Borden Ladner Gervais LLP, says that from a practical perspective, Canadian regulators may be limited to enforcing the rules here at home.

"Even though the securities commissions have a long reach, they would have to co-operate with the regulatory authorities of the jurisdiction where the issuer of the tokens is domiciled," says Mr. Pundit, a partner in the firm's securities and capital markets practice group.

"It would be difficult for any regulator to somehow compel the Swiss regulators to play ball."

All of this could leave Canadian companies at a competitive disadvantage, Mr. Adham says. "If we are subject to Canadian law and offshore companies are also subject to Canadian law but it's only being enforced on Canadian companies, how are we supposed to compete with offshore companies?"