The first reporting deadline under Canada’s Fighting Against Forced Labour and Child Labour in Supply Chains Act (the Modern Slavery Act or the Act) has passed. Entities and government institutions subject to the reporting obligation under the Act were required to submit their first annual reports on steps taken during the previous financial year to prevent or reduce the risk of forced labour or child labour in their supply chains by May 31, 2024. With reports having been submitted, now is an opportune time for businesses to turn their attention to the steps they can take to mitigate the risks of illicit conduct in their supply chains going forward.

Reporting requirements

As we have previously written, the Modern Slavery Act requires certain private sector entities engaged in (or controlling an entity engaged in) selling, producing or distributing goods in Canada or elsewhere — or importing goods in Canada — to report to the Minister of Public Safety and Emergency Preparedness on steps they have taken to prevent forced and child labour in their operations and supply chains. Reports must include information on the entity’s structure, activities and supply chains; the entity’s policies, due diligence processes and training in relation to forced labour and child labour; any remediation measures undertaken with respect to such matters; the parts of its business and supply chains that carry risk of forced labour and child labour; and the steps taken to assess and manage that risk. Reports are made publicly available on Public Safety Canada’s website and must be posted in a prominent place on each reporting entity’s website.

Through this first round of mandated reporting under the Act, many businesses have had to critically examine their supply chains and internal compliance mechanisms. With their reports now submitted, businesses should consider the steps they can take to remediate and enhance compliance processes to ensure compliance with various legal frameworks throughout their supply chains. Combatting the risk of forced labour or child labour may be top of mind, but compliance measures should also focus on other forms of economic crime such as corruption, money laundering, sanctions violations and fraud.

Risk mitigation strategies

While specific compliance measures implemented should be tailored to the risks faced by each business and the resources available, steps businesses can take to best ensure compliance throughout their supply chains include the following. Businesses may consider adopting some or all of these measures as part of their overall compliance strategy.

• Internal policies and procedures: Businesses should maintain policies and procedures setting clear expectations for all representatives — including employees, directors, officers and third-party representatives — to act ethically at all times. These may include a code of business conduct and ethics, a whistleblower policy, an anti-corruption and anti-bribery policy and an anti-money laundering and sanctions policy.
• Know-your-counterparty (KYC) measures: At all times, businesses should be familiar with counterparties with whom they do business. Related measures may include screening and identification measures to ascertain the identity of all counterparties before doing business with them, to understand the source of funds or products and to ensure compliance with all applicable sanctions. Information and records should be accurate and kept up to date.
• Formal procurement processes: Businesses should consider implementing formal procurement processes setting out how suppliers are selected, circumstances requiring formal RFQs, approval mechanisms, confidentiality and competition requirements, due diligence and risk assessments. Businesses may also consider implementing supplier questionnaires asking prospective suppliers to disclose their compliance processes prior to being engaged.
• Supplier codes of conduct: Depending on the nature and risk profile of the business, it may be appropriate to implement a formal supplier code of conduct or to formally extend obligations under internal policies to suppliers and contractors.
• Contractual representations and warranties: Appropriate compliance representations and warranties should be incorporated into supplier agreements. These contractual provisions may include requiring: compliance with all applicable laws (including anti-corruption, sanctions, anti-money laundering and anti-terrorist financing, and human rights); adherence to the organization’s supplier code of conduct and/or other policies; taking reasonable measures to ensure compliance by their own suppliers, contractors, and representatives; and ensuring that their own supply chains are free from forced labour and child labour.
• Rights of audit: Where feasible, supplier agreements can include a right of audit over the supplier or contractor’s compliance. Specific audits undertaken may vary according to risk factors and commercial considerations, and can range from ad hoc to periodic, and from smaller measures (such as running background checks) to on-the-ground inspections of supplier facilities in higher-risk scenarios.
• Training: Training should be provided to ensure that employees and representatives are aware of their compliance obligations under applicable policies. Where appropriate, businesses may also consider conducting such training for suppliers and contractors.
• Disciplinary procedures: Representatives and suppliers that fail to comply with applicable laws or the organization’s policies should be subject to discipline up to and including termination of employment or the business relationship, which should be included in contractual agreements.

There is no one-size-fits all compliance strategy for all organizations, and the specific compliance measures undertaken should be tailored to the risks and resources of each business — including its size, industry, geographic locations and the counterparties with whom it does business. While not all of the above measures will be necessary or feasible for every organization, businesses should thoughtfully consider their areas of exposure and the steps they can take to prevent wrongdoing in their supply chains.

Looking forward

In the 2024 budget, the federal government expressed its intention to introduce legislation in 2024 “to eradicate forced labour from Canadian supply chains” and to strengthen the import ban on goods produced with forced labour amended by the Act. While no details have been made available to date as to the potential timing or scope of this legislation, other jurisdictions such as the European Union, Germany and France have implemented measures such as mandatory human rights due diligence requiring businesses to proactively assess, mitigate and prevent the risk of forced labour or child labour in their supply chains.

Regardless of whether such measures become formally required in Canada, businesses should strive to maintain effective measures to ensure compliance with all relevant laws throughout their supply chains. Such measures should be commensurate with their business risk and operations. Failure to do so can have significant consequences including hefty fines, criminal liability, the seizure of goods at the border, debarment and reputational damage. Implementing effective compliance measures will not only allow businesses to put their best foot forward in future reporting but will also guard against these adverse impacts to businesses.

As technology has evolved, Canadian authorities have grappled with novel challenges investigating and prosecuting financial crime, including those crimes involving cryptocurrency and other digital assets. Parties affected by these enforcement developments have included not only potential illicit actors, but also innocent third-party custodians of digital assets, such as cryptocurrency companies.

The Ontario Superior Court’s recent decision in Durham Regional Police Service (Re)^[1] considered the current state of Canadian authorities’ search and seizure powers over digital assets, and whether police could obtain a general warrant under the Criminal Code for seizure of cryptocurrency. The Court held that Parliament’s establishment of specific provisions for seizing digital assets — through the June 2023 introduction of special warrants under section 462.321 of the Criminal Code — precludes authorities from seizing those assets by way of a general warrant.

Background

In Durham Regional Police Service (Re), the Durham Regional Police Service (DRPS) traced bitcoins alleged to have been fraudulently transferred into digital wallets belonging to three Nigerian citizens held on Binance’s cryptocurrency exchange. In March 2023, the DRPS applied for a general warrant and related assistance under section 487.01 and 487.02 of the Criminal Code to compel Binance to transfer the subject cryptocurrency from the suspects’ wallets into a secure wallet held by DRPS.

The application judge dismissed DRPS’s application, finding it had failed to satisfy the three preconditions to issuing a general warrant under section 487.01(1), that

1. there are reasonable and probable grounds to believe an offence has been committed and that information concerning the offence will be obtained
2. it is in the best interests of justice to issue the warrant
3. there is no other provision under the Criminal Code or other Act of Parliament permitting the seizure

The application judge notably found there were a variety of other legal mechanisms that would have authorized recovery of the property, such as a restraint order under section 462.33 prohibiting Binance from “disposing of, or otherwise dealing with, any interest in the property specified in the order.”

Subsequently, in June 2023, Parliament amended the Criminal Code to add section 462.321, providing for the seizure, management, and disposition of digital assets, including virtual currency. These amendments came into force on September 20, 2023.

The decision

The Attorney General for Ontario applied to the Superior Court for orders quashing the application judge’s dismissal and compelling the Court to issue the DRPS’s requested general warrant and assistance order. The Court dismissed the Attorney General’s application.

Police cannot circumvent use of tailor-made digital asset warrants in favour of general warrants

The Court’s finding largely turned on the third precondition for issuing a general warrant under section 487.01 — that there be no other provisions that would provide for a warrant, authorization or order permitting the technique proposed by the DRPS.

The Court held that, in addition to the provision allowing for restraint orders under section 462.33, the new section 462.321 was “tailor-made” by Parliament for the seizure of digital assets held on a third-party cryptocurrency exchange. Under section 462.32, the Attorney General (as opposed to the police) may apply to a judge for a warrant to search and seize digital assets, and the Attorney General must give an undertaking with respect to damages and/or costs in relation to the issuance and execution of the warrant.

The Court noted that general warrants should play a modest role to assist police in their investigative techniques that Parliament has not addressed. It held that the proposed use of general warrants should be highly scrutinized where Parliament has authorized an investigative technique that is substantively equivalent to what the police seek, so as to prevent the circumvention of more onerous preconditions by law enforcement.

Binance’s jurisdictional concerns

The Court also heard arguments from Binance that the proposed warrant was not enforceable as against it on jurisdictional grounds, since Binance is domiciled in the Cayman Islands and not Canada. Binance argued that the proper approach was for authorities to make a mutual legal assistance request to the state in which the property in question resides. Having already dismissed the application for the reasons discussed above, the Court did not rule on the issue.

Takeaways for businesses

As technology continues to evolve, so too will the tools and techniques available to Canadian authorities to investigate and prosecute criminal activity. As we have previously written, the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) recently undertook public consultations on proposed amendments to the Criminal Code and Canada’s anti-money laundering and anti-terrorist-financing (AML/ATF) regime to address risks and vulnerabilities emerging in light of new financial technologies. These and other developments may affect not only illicit actors, but also innocent third parties.

In an enforcement context — whether or not they are the target of the investigation — companies should be aware of their legal rights and be thoughtful in their engagements with authorities. For example, while the judge in this case did not deem it necessary to address the jurisdictional issue raised by Binance, it may well be relevant in a future case.

While cooperation with authorities is in many circumstances encouraged and often advisable, companies may incur significant costs if they do not fully understand their legal rights, including understanding whether authorities have properly followed applicable procedures and whether any enforcement measures have the compulsion of law. Companies should seek advice from counsel as soon as they become embroiled in any enforcement or government investigation context to ensure their rights are understood and protected. This becomes increasingly important in an evolving enforcement framework as new technologies emerge.

In a notable development, the Canadian Securities Administrators (CSA) recently announced an extension to the compliance deadline for crypto trading platforms (CTPs) dealing with value-referenced cryptoassets (VRCAs), originally detailed in CSA Staff Notice 21-333, dated October 5, 2023 (October 2023 Staff Notice). This latest guidance, released on April 17, 2024, acknowledges many CTPs’ concerns regarding technical difficulties that they face in implementing the VRCA restrictions and reiterates the CSA’s ongoing call for industry feedback on how to regulate VRCA trading in Canada.

Background

VRCAs are designed to maintain a stable value relative to a specified fiat currency or other stable asset. The primary focus within this category has been on fiat-backed cryptoassets (FBCAs), which aim to mirror the value of a single fiat currency through reserves maintained by the issuer. The October 2023 Staff Notice outlined conditions for CTPs to continue trading VRCAs, including a mandate to delist any VRCAs from their offerings by April 30, 2024, where the corresponding VRCA issuers did not meet specified requirements.

Key updates in the April 2024 guidance

The recent CSA guidance provides an extension of the original April 30, 2024, deadline to October 31, 2024. Since it is unknown whether any VRCA issuers intend to comply with the October 2023 Staff Notice, it is possible that CTPs may be compelled to delist all VRCAs from their platform. This could result in significant technical and user challenges, including reduced trading options, increased volatility and an impact on the liquidity of certain digital assets. The CSA cited technical challenges facing CTPs as the primary reason for extending the deadline to October 31, 2024.

Moreover, the CSA reiterates its invitation to CTPs and VRCA issuers to provide input on the eventual long-term regulatory framework for VRCAs. This ongoing dialogue is crucial as it opens the door for potential adjustments based on practical insights from the very entities most affected by these regulations.

Legal considerations and the broader regulatory landscape

It is critical to note that the positions expressed in both the October 2023 and the April 2024 CSA Staff Notices are indicative of Staff views and do not carry the force of law. The legal status of stablecoins as securities in Canada remains undetermined at this juncture. These Staff Notices serve as interim measures, awaiting a more definitive regulatory framework which may involve other regulators, such as the Bank of Canada.

Investors and market participants should be aware that compliance with the CSA's interim terms does not equate to an endorsement or approval of a particular VRCA. Nor does it imply that a VRCA is safe or fully compliant with Canadian securities laws. Each VRCA, even if meeting the interim conditions, carries its own set of risks, distinct from traditional fiat currencies.

Conclusion

The extension of the compliance deadline is a significant development for CTPs and VRCA issuers, providing them with additional time to address technical issues and align with regulatory expectations. However, it also serves as a reminder of the fluid nature of CSA Staff guidance on cryptocurrency regulation. The CSA's ongoing request for feedback in its Staff Notices suggest the CSA’s desire to show that it is open to a collaborative approach to future regulations, potentially paving the way for more comprehensive governance of digital currencies in Canada. The results of this approach, at least as they relate to VRCA regulation, have yet to be determined.

CTPs and other stakeholders are encouraged to participate actively in the discussions around these regulations, contributing to a regulatory framework that supports innovation while protecting investors. The evolution of VRCA regulations will likely serve as a bellwether for broader digital asset regulations globally.

The federal government’s Budget [PDF] 2024, released on April 16, 2024, contains a number of initiatives and legislative reforms aimed at combatting financial crime in Canada, including terrorist financing, corruption, sanctions evasion, tax evasion, money laundering, and fraud. The Budget promises changes to Canada’s anti-money laundering and anti-terrorist-financing (AML/ATF), criminal, and tax regimes to create additional powers, efficiencies and incentives relating to compliance and enforcement, as well as the creation of new specialized units specifically tasked with complex financial crime.

Compliance and enforcement reforms proposed in the Budget

Amendments to PCMLTFA

The 2024 Budget introduces a number of amendments to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA), Canada’s principal anti-money laundering legislation. Following developments such as the Panama Papers and FinCEN Files data leaks in recent years, as well the June 2022 findings of the Government of British Columbia’s Commission of Inquiry into Money Laundering in British Columbia (also known as the Cullen Commission, as we have previously written about), money laundering has increasingly been seen as a significant issue in Canada.  

Consistent with this, the government has previously introduced a number of compliance reforms including establishment of a publicly accessible beneficial ownership registry (as we have previously written about, with the reporting obligations for federal corporation recently becoming effective in January 2024) and various amendments to the PCMLTFA. Those changes — discussed in further detail in our Legal Outlook 2023 articles on white-collar enforcement and financial services regulatory trends — have included, among others:

• improved information sharing between law enforcement and the Canada Revenue Agency (CRA), and Financial Transactions and Reports Analysis Centre of Canada (FINTRAC)
• whistleblower protections for employees who report information to FINTRAC
• prohibiting money services businesses (MSBs) from engaging with agents or mandataries convicted of certain offences
• a new offence for structuring financial transactions to avoid FINTRAC reporting
• new regulations requiring the mortgage sector to comply with new AML/ATF obligations

Since June 2023, the Department of Finance and FINTRAC have been engaged in a public consultation to strengthen Canada’s AML/ATF regime, seeking input regarding risks and vulnerabilities emerging in light of new financial technologies and in respect to national security risks. This consultation was concluded in August 2023.

Following this consultation, the 2024 Budget proposes a number of additional amendments to the PCMLTFA. Proposed amendments include the following:

• enhancing information-sharing abilities between reporting entities to detect and deter financial crime while maintaining privacy protections for personal information, including an oversight role for the Office of the Privacy Commissioner under regulations
• permitting FINTRAC to disclose financial intelligence to provincial and territorial civil forfeiture offices to support efforts to seize property linked to unlawful activity, and Immigration, Refugees and Citizenship Canada to strengthen the integrity of Canada’s citizenship process
• enabling AML/ATF regulatory obligations to cover factoring companies, cheque-cashing businesses, and leasing and finance companies
• allowing FINTRAC to publish more information about violations of reporting obligations and resulting administrative penalties to strengthen transparency and incentivize compliance
• making technical amendments to close loopholes and correct inconsistencies

The exact form of these amendments has yet to be announced.  

Criminal Code amendments

The 2024 Budget also included various proposed amendments to the Criminal Code aimed at combating money laundering, terrorist financing, sanctions evasion and other forms of economic crime. Specifically, the Budget introduces proposed amendments granting additional judicial powers to allow courts to

• make orders requiring financial institutions to keep accounts open for the purpose of assisting in the investigation of suspected criminal offences
• issue repeating production orders authorizing law enforcement to obtain ongoing, specified information o account activity connected to persons of interest in criminal investigations

These new proposals follow amendments to the Criminal Code introduced last year which gave law enforcement the ability to freeze and seize virtual assets with suspected links to crime (through a special warrant obtained pursuant to the new section 462.321 of the Criminal Code), as proposed under the 2023 Budget.

Additionally, the 2024 Budget includes proposed amendments to the Income Tax Act and Excise Tax Act authorizing Canada revenue Agency officials to seek general warrants through court applications.

Canada Financial Crimes Agency

In 2022, the federal government announced its intention to establish a new Canada Financial Crimes Agency (CFCA) to act as Canada’s lead enforcement agency against financial crime. As currently envisioned, the CFCA will act as a nation-wide agency whose sole purpose is to investigate highly complex crimes and enforce federal law in this area and would bring together existing law enforcement resources of the RCMP, intelligence capabilities of FINTRAC, and expertise of the Canada Revenue Agency. The 2024 Budget allocates $1.7 million over two years to the Department of Finance to finalize the design and legal framework of the CFCA.

The proposed establishment of the CFCA reflects an ongoing trend of specialized enforcement agencies or units dedicated to investigating and enforcing complex financial crimes, following criticism of Canada’s perceived lack of enforcement. In 2020, the federal government announced the establishment of the new Integrated Money Laundering Investigative Teams in British Columbia, Alberta, Ontario, and Quebec, which seek to bring together expertise from a variety of agencies to assist the RCMP in addressing high-profile cases and advancing money laundering and proceeds of crime investigations nationwide. This follows the establishment of other agencies such as the Canadian Ombudsman for Responsible Enterprise (which reviews ethics and human rights complaints) and provincial agencies such as Quebec’s Unité permanente anticorruption.

It remains to be seen what impact the proposed CFCA, and other recently established enforcement agencies, will have on Canada’s perceived lackluster enforcement record.

Measures to fight trade-based fraud and money laundering

Finally, the 2024 Budget highlights “trade-based” financial crime as one of the most pervasive means of laundering money, through which an estimated hundreds of millions are laundered each year. As described by Public Safety Canada, trade-based money laundering is the process of disguising proceeds of crime and other illicit financial flows as legitimate international trade transactions. The federal government has previously announced in its 2023 Fall Economic Statement [PDF] several proposed enhancements to the Canada Border Services Agency’s (CBSA) powers under the PCMLTFA, a well as the creation of a “Trade Transparency Unit” to detect, deter, and disrupt trade-based financial crime. The 2024 Budget proposes to provide $29.9 million over five years for the CBSA to support the implementation of its new authorities under the PCMLTFA to combat financial crime and strengthen efforts to combat international financial crime.

Takeaways for businesses

The initiatives set out in the 2024 Budget continue a trend in recent years of legislative reforms and additional enforcement developments for complex financial crime. While it remains to be seen how effective these additional measures will be, they are reflective of a regulatory and business environment in which companies are increasingly asked to demonstrate their commitment to compliance and acting ethically in the course of business. As always, organizations should apply best practices to manage AML/ATF and other financial crime risks. As the landscape continues to shift in Canada, remaining vigilant and ensuring policies are updated and revisited to ensure their compliance with all AML/ATF laws and regulations is key. Businesses should also anticipate increased coordination with provinces and territories as they begin to make legislative, regulatory and enforcement changes to respond accordingly within their own jurisdiction.

On April 5, 2024, the U.S. Securities and Exchange Commission (SEC) succeeded in its much-watched civil action against Matthew Panuwat, a former business development executive at Medivation Inc., a midcap biopharmaceutical company. The SEC’s complaint [PDF] raised a novel theory of insider trading known as “shadow trading”. Shadow trading involves the use of material non-public information (MNPI) about a reporting issuer to profit from trading the shares of a different, but “economically linked,” company. This case was unique in that the defendant was found liable for using information obtained about Pfizer Inc.’s acquisition of Medivation (the acquired), to profit from trading securities of Medivation’s competitor (the competitor) when the Pfizer acquisition (the acquisition) had not yet been publicly announced.

In this case, the SEC alleged that the defendant contravened section 10(b) of the Securities Exchange Act of 1934 [PDF] by acquiring securities of the competitor, on the basis that the acquisition would also result in a corresponding increase in the competitor’s share price. The SEC alleged that the impugned trading resulted in the defendant making a profit of US$107,066.

Background

The SEC alleged that the defendant bought short-term, out-of-the-money stock options (call options) in the competitor when he knew that the acquisition was on the verge of being finalized, but had not yet been publicly disclosed. The defendant, who was involved in the sale process, was found to have purchased the competitor’s options within minutes of learning confidential information about the potential acquisition. The SEC also alleged that the defendant knew that investment bankers in the bid process had referenced Incyte as a comparable company to Medivation and that Panuwat anticipated that Incyte’s share price would also increase following Pfizer’s takeover of Medivation. The SEC further argued that Medivation’s insider trading policy prohibited employees in Panuwat’s position from using confidential information acquired through their employment to trade in the securities of another publicly traded company. According to the complaint, the Incyte call options increased in value when news of the Pfizer takeover became public, resulting in a profit of US$107,066.

The SEC’s claim against the defendant was the first time that the SEC has attempted to expand insider trading enforcement to this type of “shadow trading”. The defendant brought a motion to dismiss the action, arguing that the SEC’s claim was deficient because (i) the SEC did not allege that the defendant had knowledge of MNPI about the issuer in whose securities he traded; and (ii) the SEC’s allegation expanded insider trading liability in a novel way without legislation or rulemaking, thus failing to provide adequate notice to market participants of the increased scope of prohibited conduct under the law.

The SEC’s “shadow trading” theory survived the defendant’s motion to dismiss the claim. The U.S. Federal Court rejected the defendant’s arguments, and found that the SEC sufficiently alleged that (i) the information about the acquisition was material, confidential and nonpublic at the time of the defendant’s trading; (ii) that trading was a breach of the defendant’s fiduciary duties and in violation his employer’s insider trading policy; and (iii) the SEC sufficiently pled "scienter" in their allegation that the defendant used the MNPI in an attempt to profit off of acquiring call options in Incyte.

At trial, the jury deliberated for just over two hours, and determined that the defendant was liable for insider trading, rendering a verdict in favour of the SEC.

Key implications

Canadian market participants should consider whether this “shadow trading” theory of insider trading liability could make its way north of the border.

There are certain fundamental differences between insider trading liability in the U.S. in comparison to Canada that are important to remember when considering whether Canadian regulators would seek to initiate a proceeding based on an allegation of “shadow trading”. Notably, under U.S. law, there is no statutory framework for insider trading liability other than the anti-fraud provisions of the federal securities laws. A person may be guilty of insider trading by trading in circumstances where they breach a duty owed to the company or have misappropriated confidential information that is considered the property of someone else. In all cases, however, a guilty mental state must be established, such as an intention to gain an improper benefit.

Conversely, in Canada, insider trading laws are defined more clearly with detailed rules. For example, under section 76(1) of the Ontario Securities Act, Staff of the Commission must prove that a respondent was in a “special relationship” with the issuer and in possession of MNPI at the time of making the trades. However, there is no requirement that the Commission prove that the respondent deliberately intended to profit off of their knowledge of MNPI.

Different results could arise under the securities laws of Canadian provinces if facts similar to the Panuwat case come before a provincial securities commission or tribunal. Most significantly, in Québec, “shadow trading” is expressly prohibited by section 189.1 of the Securities Act (Québec). It provides, among other things, that no person may use MNPI about one issuer to trade in the securities, options or derivatives of another issuer, if “their market prices are likely to be influenced by the price fluctuations of the issuer’s securities”.^[1]

In Ontario and most other provinces of Canada, “shadow trading” is not explicitly prohibited by existing insider trading laws. However, this recent decision does raise the question of whether a Canadian securities regulator would ask the commission or tribunal to exercise its residual public interest jurisdiction^[2] to find that conduct that is not a specifically identifiable violation of securities law may nonetheless warrant regulatory enforcement in the public interest. A case found to be merely contrary to the public interest alone in Ontario does not attract an administrative penalty or disgorgement.^[3] However, significant non-monetary sanctions, including a director/officer ban and trading prohibitions, could be imposed.

The novel decision relating to “shadow trading” in the United States raises important questions regarding the scope of conduct that can be, or should be, regulated as insider trading in Ontario and other provinces of Canada, particularly in light of the statutory prohibition against “shadow trading” that is already in effect in Québec. These questions may lead Ontario and other provinces to consider the adoption of statutory amendments to prohibit this type of trading, as Québec has already done, or to explore novel applications of their public interest jurisdiction to achieve a similar result. Interestingly, although the U.S. anti-fraud approach to insider trading regulation is sometimes criticized for its lack of clearly codified rules, this decision shows the potential flexibility of that approach for the SEC to develop new tools to foster investor protection and market integrity.

For years, Canada’s business and legal communities have sought more meaningful public guidance from Global Affairs Canada (GAC) on its interpretation of Canada’s sanctions. Demands for this guidance have grown since the major expansion of Canada’s Russia-related sanctions in response to Russia’s 2022 invasion of Ukraine, as we have noted in several prior posts (e.g., our posts illustrating the expansion of scope to the restricted lists of goods and technologies, as well as designated persons).

This past month, GAC, which administers Canada’s economic sanctions quietly updated its “Frequently Asked Questions” (FAQs) page to provide new guidance on Canada’s autonomous economic sanctions, including those related to Russia.

While GAC has produced some guidance over the years, most of it has avoided addressing the many thorny interpretive issues posed by the wording found in the key legal instruments used for imposing sanctions, particularly the Special Economic Measures Act, the Justice for Victims of Corrupt Foreign Officials Act and the regulations under them. These new FAQs do aim to address some of these issues, offering expansive interpretations in several key areas, specifically: the scope of the anti-facilitation provisions; when entities are considered owned or controlled by a sanctioned person; and indirect dealings with sanctioned persons, including the acquisition of goods from a non-sanctioned foreign supplier that uses inputs sourced from a sanctioned entity. However, the guidance, however well intentioned, further complicates compliance efforts for Canadian businesses and those Canadians working in foreign companies, by signaling an expanded risk.

While these interpretations do not have the force of law, because they can be presumed to reflect the positions of Canada’s administrative and enforcement authorities, they change the risk calculations for Canadian businesses with international supply chains and Canadians employed abroad in foreign businesses.

To assist individuals and businesses in navigating these new interpretations, and stay up to date on the impact of this new guidance, Osler published an update on April 1, for those who might have missed the release of these FAQs, to summarize the guidance and what it means for Canadian business.

Please see here to access the update.

Since the integration of Canada’s two capital markets self-regulatory organizations (SROs) — the Mutual Fund Dealers Association (MFDA) and the Investment Industry Regulatory Organization of Canada (IIROC) — in January 2023, market observers, investors and SRO members have been waiting for the Canadian Investment Regulatory Organization (CIRO) to release its proposal as to how SRO rules would be consolidated. Earlier this year, CIRO published a consultation paper regarding policy options for leveling the advisor compensation playing field. The consultation paper proposes potential amendments to the Investment Dealer and Partially Consolidated Rules (IDPC Rules) to harmonize acceptable Approved Person compensation approaches.

Currently, Approved Persons under the Mutual Fund Dealer Rules (MFD Rules) are permitted to structure their compensation through personal corporations, except in Alberta. Conversely, Approved Persons governed by the IDPC Rules (including investment dealer representatives) are not permitted to structure compensation using this approach.

To develop a more consistent approach to Approved Person compensation, the consultation paper proposes three possible approaches to Approved Person compensation under the IDPC Rules, each of which is canvassed in this post:

1. an “enhanced directed commission approach”
2. an “Incorporated Approved Person approach”
3. a “registered corporation approach”

Notably, CIRO’s preferred approach is the Incorporated Approved Person approach, which would permit Approved Persons under the IDPC Rules to use personal corporations (approved by CIRO) to structure their compensation.

Three proposed approaches to structuring compensation for Approved Persons

Option 1: Potential amendments to enhance the existing directed commission approach

The MFD Rules permit mutual fund dealers to utilize a “directed commission arrangement” whereby an Approved Person may request that their sponsoring dealer member pay commissions or fees they have earned in respect of business conducted by the Approved Person on behalf of the dealer member to an unregistered corporation.^[1] The IDPC Rules currently prohibit these arrangements and require remuneration to be paid by an investment dealer directly to an Approved Person.^[2]

In considering whether to adopt a directed commission approach similar to the current approach under the MFD Rules, CIRO proposes an “enhanced directed commission approach”. Under this approach, Approved Persons could request that a portion of commissions or fees they have earned, relating to non-registerable activities the corporation has carried out, could be directed to a personal corporation owned by the Approved Person (alone or with other Approved Persons and their family members). This approach would allow for vetting of corporation owners and activities, thereby addressing potential risks to investors. Under this proposed approach, CIRO would aim to address concerns that there may be insufficient transparency of the beneficial owners’ activities within the corporations who currently receive directed commission payments. Specifically, CIRO has identified that it would need enhanced jurisdiction to determine whether an Approved Person who uses this approach is ensuring that the corporation is limiting its activities to non-registerable activities.

To address CIRO’s concerns with the existing directed commission approach, CIRO has proposed that its rules could be amended to include provisions that would

• place limitations on corporation ownership, which would likely limit ownership to Approved Persons and their immediate family and/or a family trust
• place limitations on securities and other activities that may be conducted within the corporation (i.e., limit other corporate activities to financial services activities and, where appropriate, other activities approved by the dealer member)
• require that the sponsoring dealer member verify compliance with these requirements

CIRO’s objective for these proposed rule amendments to the directed commission approach is to enhance investor protection by introducing limits to the ownership of and activities conducted within the corporation, as well as requiring dealer member oversight of these activities.

Option 2: Incorporated Approved Person approach

CIRO staff have indicated that their preferred policy option is the Incorporated Approved Person approach. This approach would permit Approved Persons under the IDPC Rules to use personal corporations (approved by CIRO) to structure their compensation. Adopting this approach for use by all Approved Persons who only engage in non-registerable activities within the corporation could be achieved through amendments to CIRO Rules alone. This approach would also provide Approved Persons with the possibility of being able to engage in registerable activities within the corporation to the extent that securities legislation in certain provinces and territories is amended to allow for it.

The Incorporated Approved Person approach would be implemented through CIRO rule amendments to introduce a new category for non-individual Approved Persons (Incorporated Approved Person category).

The consultation paper specifies the requirements that applicants would need to satisfy and requirements for the execution of the Incorporated Approved Person Agreement, including the following:

• The corporation must be a professional corporation in those jurisdictions in which becoming a professional corporation is available as an option.
• All activities conducted within the corporation on behalf of the sponsoring Dealer Member must be conducted in the name or trade name of the sponsoring Dealer Member.
• Activities conducted for others within the corporation would be limited to
  • other licensed activities in the financial services industry
  • other activities that have received advance sponsoring Dealer Member approval
• An Incorporated Approved Person Agreement in a form acceptable to CIRO must be entered between the sponsoring Dealer Member, the Incorporated Approved Person (i.e., the corporation) and the Approved Persons acting on their behalf.

Additionally, the Incorporated Approved Person Agreement would require that the Dealer Member supervise the Incorporated Approved Person and its Approved Person employees and agents. The Dealer Member would also be liable to clients and other third parties for acts and omissions of the Incorporated Approved Person.

Option 3: Registered corporation approach

Finally, the third option, the registered corporation approach, contemplates that the corporation owned by the Approved Person in which activities are carried out on the sponsoring dealer member’s behalf would be required to register in the relevant CSA jurisdictions. The approach would require CIRO rule amendments as well as securities legislation amendments to introduce a new registration category and associated requirements for the registered corporation. CIRO suggests that these legislative provisions could include eligibility requirements similar to those described above for applicants under the Incorporated Approved Persons approach.

Benefits cited for the registered corporation approach include a higher level of regulatory oversight and enhancements to investor protection. However, a drawback of this approach is the additional requirements that would be imposed not only on Approved Persons, their sponsoring dealers and the Approved Persons’ corporations, but also on CIRO and CSA registration staff.

Implications

The consultation paper moves the needle significantly towards a vision for greater consolidation of rules and regulatory approach. CIRO has identified a common concern with each of the three proposed approaches: namely, that amendments to securities legislation in each province and territory in Canada would need to be enacted to allow Approved Persons to engage in and to be compensated for registerable activities within the corporation. Furthermore, given the provincial and territorial jurisdiction over securities regulation in Canada, there may be differences in the nature and timing of the securities legislation amendments in each province and territory that would permit an Approved Person’s corporation to engage in and to be compensated for registerable activities.

Dealer members and Approved Persons will also need to consider how implementing these arrangements may affect their current business models, taking into account operational, employment, supervisory and client relationship considerations.

There are also significant tax considerations that regulatory authorities and industry participants will need to consider in tandem with the CIRO proposals to ensure that the desired tax outcomes are achievable.

We will continue to monitor and report on developments.

Although cryptocurrencies have been widely available for around 15 years — if one counts from the introduction of bitcoin — the industry is still in an early phase of its evolutionary journey. The industry has suffered from growing pains, punctuated by several cycles of rapid expansion and retraction and by the well-publicized collapse of several businesses. As we have previously written, regulators have struggled to fit cryptocurrency into existing regulatory regimes, and attempts to impose regulatory oversight over cryptocurrencies have, on occasion, been met with stiff resistance. These factors have collectively shaped the public's view of the cryptocurrency industry, contributing to the formation of certain perceptions that do not necessarily accord with the broader realities of its use and applications.

One such perception is that cryptocurrency is disproportionately used in illicit activity, such as in the trade of illicit drugs and other forms of illegal activity.

Interestingly, the Chainalysis 2024 Crypto Crime Report suggests that this perception may be unfair and exaggerated. The report suggests that the rate at which crypto is used in illicit economic activity is holding steady or falling, and is equal to or less than the overall incidence of illicit activity globally.

The report’s findings

Chainalysis, a blockchain research and data platform providing services in over 70 countries, recently published its annual Crypto Crime Report, which examined the latest trends in ransomware, scams, hacking and other illicit activity in the blockchain space.

In the report, the research firm found that illicit activity in global crypto markets dropped from an estimated US$39.6 billion in 2022 to US$24.2 billion last year. Comparatively, the American Banker and OODALoop estimate that illicit money flows in traditional fiat currency totalled over $3 trillion globally in 2023. Chainalysis estimates that the share of all crypto trading volume involved in illicit activity declined from 0.42% in 2022 to 0.34% in 2023. While the 2023 numbers are likely to rise slightly as further illicit activities are discovered and as individuals and companies are convicted of related crimes, the decline in crypto-related crime represents a promising trend for investors and those interested in the space.

According to the report, three key trends define the current crypto crime landscape:

1. Scamming and stolen funds are down significantly. Both crypto scamming and hacking revenue fell significantly in 2023, with total illicit revenue for each down 29.2% and 54.3%, respectively. These declines contributed greatly to the total decrease in illicit crypto activity in 2023. The large dropoff in stolen funds is largely due to a decline in decentralized financial application (DeFi) hacking, which may signify that DeFi protocols are improving their security practices. The report warns that while the trend in scamming is promising, approval phishing and romance scams remain large threats.
2. Ransomware and darknet market activity is on the rise. In contrast with overall trends, ransomware and darknet markets saw revenues rise in 2023. Ransomware payments hit a record high in 2023, exceeding $1 billion. Various factors contributed to this rise, including growth in the number of threat actors, adaptation to overcome organizations’ cybersecurity improvements and increase in “big game hunting” (i.e., targeting larger institutions). Concurrently, darknet market revenue increased after a 2022 decline resulting from the shutdown of Hydra, once the world’s most dominant market. Darknet revenue is still down significantly since 2021 and no other market has matched Hydra’s financial success.
3. Transactions with sanctioned entities drive the vast majority of illicit activity. Sanctioned entities and jurisdictions accounted for a combined $14.9 billion worth of transaction volume in 2023, which represents 61.5% of all illicit transaction volume measured by Chainalysis. Sanctions-related transactions are making up a larger share of all illicit transaction volume year-over-year, in part due to the number of entities being sanctioned and the difficulty of enforcing sanctions against entities in regions that don’t comply with the U.S. Department of the Treasury's Office of Foreign Assets Control (OFAC) designations.

According to the report, money laundering also declined in 2023, with illicit addresses sending $22.2 billion worth of cryptocurrency to services — a significant decrease from the $31.5 billion sent in 2022. Market manipulation, child sexual abuse material (CSAM) and terrorism financing were also discussed, but did not contribute significantly to the 2023 trends.

Crypto’s stigma is unwarranted

As the report itself notes, tracking the extent to which cryptocurrency is used in illicit transactions is difficult to pin down. Nevertheless, according to the report, the share of crypto trading volume involved in illicit activity has held steady at less than 0.5% since 2020. Notably, this share is much lower than illegal activity as a percentage of global GDP. In 2009, the United Nations Office on Drugs and Crime estimated that transnational organized crime generated 1.5% of global GDP.^[1] In Canada, it is estimated that underground economic activity accounts for 2.7% of GDP.^[2]

Accordingly, there are valid grounds to argue that crypto assets have been improperly and unfairly stigmatized as being associated with illegal activity. Compared to the illicit share of global and Canadian GDP, crypto does not appear to be disproportionately used in illegal economic activity. Businesses and financial institutions should remain alive to the potential stigmatization of crypto assets, particularly as regulators continue to attempt to impose regulatory oversight over this transformative and unique industry. The findings from the Crypto Crime Report indicate that the perception of cryptocurrency primarily serving illicit activities is unwarranted.

On February 21, 2024, LexisNexis Risk Solutions published its True Cost of Financial Crime Compliance Study, reporting on the results of a global online survey to evaluate the cost, current state, and challenges presented by financial crime compliance operations amongst financial institutions. From May to June 2023, the survey sought input from 1,181 senior decision-makers at financial institutions, with 160 participants from the U.S. and Canada.

The study revealed that financial crime compliance costs have increased 98% for both Canadian and U.S. financial institutions, with industry costs soaring to $61 billion, and that financial institutions are keen to prioritize finding efficiencies to cut costs. As the study reveals, technology and outsourcing have been top of mind for financial institutions, both large and small, to deal with the increasingly complex compliance regulatory landscape and heightened customer expectations.

These rising costs underscore the importance of designing a tailored and purposeful compliance plan which reflects the unique risks facing each organization and its business. Despite rising costs, prioritizing a strong compliance foundation and investing in solutions to address organizations’ specific pain points can still be cost-effective, without sacrificing adherence to regulators’ ever-increasing expectations.

Top drivers of compliance costs for financial institutions

The study identified the escalation of financial crime regulations and heightened regulatory expectations as primary factors driving increases in compliance costs, which is likely a product of both increased criminal use of advanced technology and mounting pressure on regulators to tackle modern financial crimes. Among other things, the growth of crypto currency and digital payments, along with the potential for fraud and supply chain or trade-based money laundering, has attracted particular scrutiny from regulators. Further, Canada has been singled out internationally for its perceived lax regulation and enforcement of anti-money laundering (AML) and anti-terrorist financing (ATF) conduct — Transparency International has consistently placed Canada in the bottom ranking of G20 countries in its ability to meet G20 AML commitments.

Financial institutions are largely perceived as key players in the fight against modern financial crimes and have thus faced the brunt of the regulatory burden in recent years. For instance, through the federal government’s Budget 2023, several legislative reforms were introduced to Canada’s AML/ATF regime, including new powers awarded to the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) to levy administrative monetary penalties against violators’ directors, officers and agents, the criminalization of unregistered money services businesses (MSBs), new obligations for the financial sector to report sanctions-related information to FINTRAC, and new authority to the Minister of Finance under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) to impose enhanced due diligence requirements to protect Canada’s financial system from the financing of national security threats. Further, as we discussed in our Osler Legal Outlook article, new regulations will come into force on October 11, 2024 requiring the mortgage sector to comply with new AML/ATF obligations and, beginning on April 1, 2024, FINTRAC will implement a new cost-recovery funding model imposing compliance costs on banks, federally regulated trust and loan companies and life insurance companies, as well as any reporting entities under the PCMLTFA that submit 500 or more threshold reports during the fiscal year.

The study identified that regulatory changes in both the U.S. and Canada have led to increases in screening alert numbers and steep increases in compliance workloads. Compliance obligations — most notably related to know-your-client (KYC) identification and verification measures — are also running up against increasing customer expectations for near-instant gratification when completing financial transactions and payment processing. Surveyors in the study expressed feeling stuck in the precarious position of balancing customer satisfaction with regulatory adherence.

Financial institutions, both large and small, have been turning to technology and outsourcing to ease the labour burden associated with compliance in modern times:

• 80% of compliance departments reported that they were seeking opportunities to automate some of their activities in the next three years
• 78% of respondent financial institutions were looking to outsource some of their activities in the next three years, and
• 79% of respondent organizations noticed rises in technology costs related to compliance and KYC software in the past 12 months, while technology costs associated with networks, systems and remote work have increased for 75% of businesses

The study ultimately recommended that financial institutions focus on finding the right partners (such as financial crime technology partners) to complement their in-house compliance teams and embrace new technologies to respond to new financial crimes, such as artificial intelligence/machine learning-based compliance models, privacy-preserving technologies, and advanced analytics in their financial crime compliance solutions to identify new crime patterns rapidly.

Businesses should not lose sight of core compliance principles

Financial institutions and other businesses alike have recognized the need to invest in compliance measures to safeguard against the serious consequences of compliance failures — legal challenges, regulatory enforcement actions, hefty fines, and significant reputational damage. Outside the financial sector, businesses are similarly facing the burden of compliance with domestic and foreign anti-bribery and corruption laws, ESG reporting requirements, and Canada’s new modern slavery regime (as we have previously written).

The rising costs of compliance measures underscore the importance of taking a thoughtful approach to compliance to ensure resources are effectively deployed to address the risks facing each company. There is no one-size-fits all compliance strategy for all organizations and there is no one all-encompassing software solution that will solve every compliance challenge: a truly cost-effective compliance strategy should be tailored to the risks associated with an organization’s industry, geography, and the counterparties with whom it does business. Further, while the innovative solutions outlined in this recent study are welcome tools, they are not a replacement for and should only serve to complement a solid compliance foundation, which begins by fostering a culture of compliance throughout the organization (by setting a “tone at the top” of compliance), setting clear expectations through policies and procedures, and providing adequate training. If done right, building a strategic and effective compliance program is an investment that will pay for itself in the long run.

On January 26, 2024, Ontario’s Capital Markets Tribunal (the Tribunal) approved a settlement [PDF] in the matter of Nicholas Agar and Paul Ungerman (the respondents), representing the first time the Ontario Securities Commission (OSC) has settled allegations relating to the promotion and sale of cryptocurrency tokens.

Although the Tribunal was clear that it was not adjudicating whether a cryptocurrency token constitutes a security, this matter highlights the OSC’s commitment to enforcing the Securities Act (the Act) in respect of cryptocurrency assets, notwithstanding that the status of such assets under the Act is still unclear.

Background

As is typically the case in OSC settlements, the settlement agreement came before the Tribunal on the basis of a set of agreed facts. The parties agreed that between 2018 and 2022, the respondents and the corporate entities they controlled (the Axia Entities) created and raised approximately US$41 million from investors worldwide through the sale of cryptocurrency tokens (Axia Coin), including US$9 million from over 200 Ontario investors (the Axia Project). The respondents facilitated the sale of Axia Coin and/or future entitlements to Axia Coin to Ontario investors in various ways. The Axia Project was initially operated through an Ontario company controlled by the respondents before moving offshore in 2019.

The respondents continuously disseminated promotional materials for Axia Coin and actively promoted its profitability, including claims about its unique “tokenomics” that allegedly provided a “safe haven” for purchasers and increased the value of Axia Coin over time. The respondents also promoted that Axia Coin had a purported asset reserve of US$29 billion, was the world’s first asset-supported or -backed global cryptocurrency and would be tradeable on a trading platform to be built on their network. At the time, Axia Coin was traded on third-party exchanges with promises of listings on further exchanges.

In October 2022, the respondents announced the suspension of all Axia Coin sales. In March 2023, they announced the beginning of efforts to wind down the Axia Project. As part of this wind down, less than US$10 million of the US$41 million raised remained for distribution to investors.

The settlement agreement

On January 10, 2024, OSC Staff issued a Statement of Allegations alleging that the respondents committed various breaches of the Act in connection with the Axia Project and that they misled Staff in the course of Staff’s investigation into the matter. Also on January 10, 2024, the parties entered into a settlement agreement [PDF].

In this agreement, the respondents acknowledged and admitted that they, and Axia Entities as applicable: (i) made misleading or untrue statements in contravention of ss. 126.2(1) of the Act, (ii) breached the registration and prospectus requirements under ss. 25(1) and s. 53 of the Act, (iii) made a number of misleading, incomplete or untrue statements to OSC Staff about the nature and extent of the business activities of the Axia Project in contravention of ss. 122(1)(a) of the Act, (iv) authorized, permitted or acquiesced in Axia Entities’ non-compliance in contravention of s. 129.2 of the Act and (v) engaged in conduct contrary to the public interest.

The parties agreed that

• Axia Coin are securities
• the respondents and Axia Entities engaged in the distributions of securities without filing a preliminary prospectus or prospectus and without an applicable exemption from the prospectus requirement
• the respondents and Axia Entities engaged in, and held themselves out as engaging in, the business of trading in securities without being registered to do so and without an applicable exemption from the registration requirement

Each of the respondents agreed to pay an administrative penalty of $550,000 to the OSC, as well as disgorgement and a contribution toward the cost of Staff’s investigation. They also agreed to lifetime trading and officer/director bans.

The Tribunal’s reasons for approval

The Tribunal approved the settlement, finding that the terms of the settlement agreement fall within a range of reasonable outcomes in the circumstances and that the agreement properly reflects the principles underlying the application of sanctions, including recognition of the seriousness of the misconduct and the importance of fostering investor protection and confidence in the capital markets.

In reaching this conclusion, the Tribunal noted the novelty of the matter, including that it represents the first time the OSC is settling allegations relating to the promotion and sale of cryptocurrency tokens and that the Tribunal has not previously decided any contested matters in relation to the promotion and sale of cryptocurrency tokens or the circumstances in which they may be considered a security. For the purpose of the settlement agreement, the parties agreed that the tokens were securities. The panel noted that they had not had the benefit of argument over the attributes of the token and whether it is properly characterized as a security. Nevertheless, the panel held that the parties had “admitted and agreed to circumstances that justify” the imposition of the agreed-upon sanctions.

Key takeaways

While the impact of this settlement on future OSC investigations and Tribunal decisions relating to cryptocurrency tokens remains to be seen, it nonetheless reinforces the seriousness with which the OSC will treat contraventions of Ontario securities laws in the context of cryptocurrencies and the enforcement of those laws irrespective of where businesses are domiciled.