US Regulators Assert Broad Jurisdiction Over Offshore Cryptocurrency Trading Platforms – Finance and Banking – Canada – Mondaq News Alerts

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Recent actions filed in early October 2020 by the U.S.Department of Justice (the "DOJ") and the CommodityFutures Trading Commission (the "CFTC") against BitMEX, alarge cryptocurrency derivatives exchange incorporated in theSeychelles, highlight how virtual asset exchange platforms can besubject to the law and potential enforcement action in multiplejurisdictions based on the locations of their customers. Shortlyafter the filing of these actions, the DOJ published itsCryptocurrency Enforcement Framework, which emphasized that the DOJasserted jurisdiction over virtual asset transactions based notonly on the location of customers but also contacts with"financial, data storage, or other computer systems within theUnited States". These broad assertions of jurisdiction by U.S.prosecutors and regulators, and similar assertions of jurisdictionover foreign trading platforms by Canadian regulators, are acaution to virtual asset exchange platforms to carefully considerthe steps taken to limit their contact with jurisdictions in whichthey do not wish to do business.

Since September 2015, the CFTC has taken the position thatBitcoin and other virtual currencies are commodities under theCommodity Exchange Act. Accordingly, it is the CFTC'sposition that entities that offer leveraged retail transactions,futures, options or swaps for commodities are required to registerwith the CFTC as a future commission merchant (a"Merchant") as well as comply with theBank Secrecy Act, which requires Merchants to establish,implement and maintain an adequate anti-money laundering("AML") program. As part of the AML program, a Merchantis required to implement a written "know your client"("KYC") program that includes risk-based procedures forverifying the identity of its clients. At a minimum, a Merchantmust collect the name, date of birth, address and governmentidentification number of each client prior to their opening anaccount on the Merchant's platform.

In light of the position taken by the CFTC in 2015, BitMEXannounced it was withdrawing from the U.S. market and implementedan Internet Protocol ("IP") address check, also known as"geo-blocking", designed to block U.S. residents fromaccessing the BitMEX trading platform. BitMEX did not,however, implement a KYC program for all of its clients.

On October 1, 2020, the DOJ filed criminal charges (the "DOJAction") accusing four executives of BitMEX of evading rulesdesigned to stop money laundering. That same day, the CFTCannounced that it had filed a related civil enforcement action (the "CFTCAction" together with the DOJ Action, the "BitMEXActions") against five entities and three individuals that ownand operate BitMEX, alleging that they had operated an unregisteredtrading platform in violation of multiple CFTC regulations,including failing to implement required anti-money launderingprocedures.

The BitMEX Actions allege that, since BitMEX's launch inNovember 2014, BitMEX has actively pursued and served thousands ofcustomers located in the U.S., even after its announced withdrawalfrom the U.S. market in 2015. In particular, the DOJ alleges thatBitMEX or its representatives:

Notably, the DOJ alleges that BitMEX's geo-blocking of U.S.IP addresses was deficient and failed to prevent U.S. persons fromtrading on the BitMEX platform. In particular, the DOJ allegesBitMEX failed to implement measures to restrict access to itsplatforms by clients using a virtual private network("VPN"), which can beused to mask the location of a computer's IP address andthereby circumvent geo-blocking.

Based on these allegations, the DOJ and the CFTC allege thatBitMEX failed to register with the CFTC as a Merchant as requiredby the Commodities Exchange Act and knowingly operated itsplatform in violation of multiple CFTC regulations and the BankSecrecy Act, including applicable AML and KYCrequirements.

The BitMEX Actions confirm the willingness of U.S. regulators toassert jurisdiction over virtual asset exchange platforms operatingfrom outside the United States but allegedly with customers orother contacts within the U.S.

As well, shortly after the DOJ Action was filed, the DOJpublished its Cryptocurrency Enforcement Framework, a reportsummarizing its cryptocurrency-related enforcement work to date. Inthis report, the DOJ emphasized its position that it has"robust authority" to prosecute virtual asset serviceproviders and other entities that violate U.S. laws even when theyare not located inside the U.S. The Report asserts that"[w]here virtual asset transactions touch financial, datastorage, or other computer systems within the United States, theDepartment generally has jurisdiction to prosecute the actors whodirect or conduct those transactions."

Like U.S. regulators and prosecutors, Canadian regulators alsotake the view that they have jurisdiction over online securitiestrading platforms operated from outside Canada but with Canadianclients. For example, in September 2018, the Ontario SecuritiesCommission (the "OSC") reached a settlement[PDF] with eToro (Europe)Limited ("eToro"), a Cyprus-based company that hadengaged in online trading of securities or derivatives with Ontarioresidents, including contracts for difference based on exposure tounderlying assets which included cryptocurrencies and stocks. eTorowas not a reporting issuer in Ontario, nor was it registered toengage in the business of trading in accordance with Ontariosecurities law. Nonetheless eToro operated approximately 2,500accounts for Ontario residents between 2008 and 2017. The OSCsettled an enforcement action with eToro based on, among otherterms, a CAD$550,000 administrative penalty, disgorgement of nearlyUSD$2 million, and an undertaking to return funds to Ontarioaccountholders.

Online virtual asset exchange platforms that do not intend toaccept U.S. and Canadian residents as clients nonetheless need tobe careful about inadvertent non-compliance with U.S. or Canadiansecurities, derivatives, money transmission or other laws. At aminimum, platforms need to consider adequate measures to preventresidents from these jurisdictions from accessing their services,but as the DOJ's Cryptocurrency Enforcement Framework notes,prosecutors or regulators may assert jurisdiction based onfinancial or technical contacts. Regulators appear to be highlyskeptical of geo-blocking of IP addresses, which suggests that morerobust KYC processes should be considered to exclude residents fromcertain jurisdictions.

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US Regulators Assert Broad Jurisdiction Over Offshore Cryptocurrency Trading Platforms - Finance and Banking - Canada - Mondaq News Alerts