At the start of last month I had a conversation with the founder of a well-known cryptocurrency company. They said "you should write an article". After a busy September, I've found the time to do so. Below is an article about the contested authority of securities regulators over cryptocurrency, in the context of shifts happening in US jurisprudence. Although these changes haven't been felt in Canada yet, and have had little impact even in the US, I believe it's quite possible we'll see this line of legal thought become important in the coming years. This article is a bit less concise than it could have been so that it is accessible.
A Lack Of Statute & Regulation: Purported Authority Over Cryptocurrency
Securities regulators have a lot to say about cryptocurrency. Their pronouncements and speeches are regularly given space in industry news, and sometimes even in mainstream news. In the United States, many people in the crypto industry can name specific leaders of regulators, and what their recent speeches have been about. In Canada, industry participants and lawyers carefully read each
staff notice that's issued. The basis of their authority to make these decrees is, by their reckoning, general purpose laws that date to somewhere between 50-80 years ago. In Canada, these laws are significantly shaped by legislative attempts to control fraud by people in the mining industry who would promote their latest supposed-find of gold, silver, etc. The modern day regulators that were spawned by these laws now claim authority over much of the cryptocurrency industry.
Cryptocurrency is not like fake gold mines. The math behind cryptocurrency was invented more recently than the laws that purportedly govern it. Is it really the case that these laws do govern cryptocurrency, despite it not being conceived of at the time and being fundamentally different?
The above question is not to doubt the authority that securities regulators have over old-fashioned investment, like a company raising money for investors to build a technology. But this is fundamentally different than the activities of a company selling something (cryptocurrency) to buyers. Similarly, no one doubts the authority of securities regulators to regulate stock markets, which is a key raison d'etre of these regulators. But to really understand where the authority exists (or doesn't) it is important to take both a step back in legal history, and also look at recent decisions of the US Supreme Court that propose a significant shift in how regulators operate.
Modern Regulators: How They Work
Once upon a time, the government made laws and generally courts enforced it. Then, a new idea was conceived of: create laws that make new parts of the government, and empower those parts of the government to create new rules and enforce them. This approach bypasses courts and created massive new bureaucracies to regulate all manner of aspects of Canadian and American life (the same idea spread globally, but this article is just about my country and its highly-influential neighbour). Modern law works by
delegating authority to a regulator, who then comes up with rules. In this model, which is the dominant one for modern law, legislators (the people you vote for) don't make most of the rules. Securities regulators are empowered to come up with their own rules and then enforce them, without going back to Parliament. This is seen as being easier, but it's also seen as being better, because people who are technical experts come up with the rules, instead of people who are legislators.
The people you vote for don't make the rules. The people they appoint and long-term employees of the bureaucracy make the rules. Unfortunately, almost all regulators are tasked with patrolling a huge swath of activities and they almost never have the resources to properly do so. So then they make more choices about what to actually do: selective enforcement of laws. So the regulators aren't just making the rules, they're also deciding which parts of the laws the government made (and their own rules) to enforce at any given time, which is driven by their own ideas about what would be best for society. The laws that are passed by Parliament are made very broad, and the regulators get to choose later what to do. Sometimes they choose to do things that were never even contemplated when the laws were passed.
Unsurprisingly, not everyone is happy about such wide powers that have been granted to regulators. Or more accurately, they're not happy with the results. Many regulators are not just
judge, jury, and executioner, they also make the rules that they judge, and sometimes they make rules people don't like. In the world of securities laws, this takes the form of making rules and then also making exemptions from the rules. In Ontario, the securities regulators regularly provide what is called
exemptive relief where companies are given a limited exception from having to follow the law. So the regulator is making the rules, enforcing the rules, and granting special dispensation to not follow the rules. There's rarely a published formula for how exceptions are made, and they theoretically don't have precedent value. To provide some stability, the regulators then issue what is termed
regulatory guidance which gives their non-binding view on what they think the law is. In Canada, lawyers treat this non-binding opinion as if it is a pronouncement of the law. In part they do so because the government enforces laws based on these regulatory guidance documents. So the law is a combination of statutes, regulations, agency-created rules, agency-created exceptions from the rules, and agency-created documents that articulate their view of how they think they will follow the law combined with how they think companies should act to stay within their interpretation. These regulatory guidance documents are often effectively a way to get around limits on the regulators ability to make new rules, because there's a much easier process to make these, under the theory that they're not really law since they're non-binding. If you're not confused by all of this, you're probably a securities lawyer or you've had a lot of dealings with one! These rules are issued at a quick pace, and it's almost impossible for non-specialists to keep up.
In addition to the above, regulators also make use of the news as a means of carrying out their mission. They issue press releases and try to pick cases that will have an impact. The idea is that they'll make examples of certain people to try to achieve their goals without having to take on lots of companies. None of this is ever described on the websites of regulators and how all of this works remains a mystery to the average person. Almost everyone who needs to seriously engage with a securities regulator will find themselves in need of a securities lawyer to intermediate and understand the rather arcane workings of these regulators and their thousands of pages of rules they've written.
The vast majority of issues in securities law are decided at the level of securities regulators. Their plans and regulatory approaches become de facto law. In the world of cryptocurrency, many lawyers have built their careers around reading these tea leaves and triangulating government intentions so that their clients can navigate this ever-changing system. Their clients rarely take on the government directly because few shareholders have the stomach to shell out a million dollars to fight the government. One notable exception in Canada is the efforts of 3iQ to overturn the rules (de facto rules, established by the securities regulators) that banned exchange-traded funds (ETFs) from operating based around cryptocurrency portfolios. 3iQ won, the government was wrong, and now there's a thriving multibillion dollar industry in Canada of providing cryptocurrency ETFs. In America, there is still no crypto ETF, although many people are trying to fight the main American regulator to permit this. I have no doubt that Americans will eventually gain access to the same type of funds as exist in Canada.
In Canada and the US, regulators have attempted to build a regulatory system around cryptocurrency. Since it's not mentioned in any law, they have had to rely on existing authority and the various tools in their toolbox that I described above. The key pushback on this system may come from a series of US Supreme Court decisions that are changing how administrative action is taken in the US.
Challenging The Authority Of Regulators To Invent New Systems
People in government often view the current system as providing
flexibility and permitting
innovation with respect to rules. But the people on the receiving end of these rules don't agree that what they are seeing is flexible or innovative. They see government overreach. But for the past many decades, in Canada and the US, basically if the government did it then it's fine. Courts have deferred to regulators and their invented approaches to regulation. Virtually every lawyer in Canada is
pro-regulation and even the business community regularly expresses their interests in seeing
smart regulation or some such thing. The idea of challenging the authority of a regulatory scheme is alien to most people in part because that's now how the law has developed.
An example of the above regulator supremacy, a famous US Supreme Court decision from 1984 is widely considered to stand for the idea of significant deference being given to the decisions of regulators. But there's now new battles looming as a result of a decision involving the same law as in 1984, but on a different point. The US Supreme Court ruled last year that just because the regulator can cite some authority for their actions (i.e. a regulation or statute) that doesn't mean that whatever they decide is the end of the issue. The edge of the governments' authority to make rules without new authority from Parliament is whether or not a law really intended to grant that authority. This is circular in a way, but in an important 2022 decision, the court ruled that the government couldn't invent a new carbon emissions cap and trade system by invoking authority intended to regulate smokestacks. Obviously Parliament didn't intend to make such a law decades ago, and it was never used for that purpose up until very recently when the Environmental Protection Agency decided to create a system because they felt that a law wouldn't be forthcoming. This sort of unilateral action by regulators is relatively common and until recently was often blessed by the US Supreme Court. But it seems the pendulum is swinging the other way.
In a decision issued in June, the US Supreme Court applied similar logic as the carbon case to an attempt to cancel student loans. The executive branch of the government attempted to use a law passed in the early 2000s called the HEROES Act to forgive hundreds of billions of dollars of loans. But the law was obviously not intended to do that, and it was originally made to provide limited relief from student loan payments for soldiers at war in the Middle East. The Supreme Court said that the law was not intended to be what the government said, even if it could be read that way. The right way to read the law isn't the way with the most expansive reading and the widest authority claimed.
These recent US court cases are a move away from the approach that previously reined, which was something more like
will good things happen if the government is allowed to do what they want?. But laws that are interpreted based on good or bad results is not really the application of law, that's more like what Parliament does. Parliament can change any laws they want and can repeal or make new ones if they'd like to. But because there isn't political consensus in favour of certain changes that bureaucrats would like to see, they frequently attempt to make rules without going back to the legislature. Courts in Canada may start to follow the American approach, which might impose new limits on the ability of regulators to dream up their own systems that elected representatives never thought of. This limit is referred to in US law as
the major questions doctrine.
To non-experts, the above discussion may sound very technical or even wrong. Government officials almost never say what they're doing in a plain way, in part because they're afraid of legal challenges, but also because they genuinely view their initiatives as being great for everyone. Rules simply get in the way of accomplishing their utopian (or, less charitably, politically-inspired) ideas. Everyone wants to make big new systems. They've got great ideas! But the law just isn't there. For example, the US executive branch knew that they would not get a new law passed to give away hundreds of billions of dollars to college graduates. So they bypassed that process and attempted to do it anyway. They searched far and wide to find the HEROES Act, and then used that as the basis of their authority because there is a way to read that law that does give them that authority. But the law was not meant to mean that. When passed, no one contemplated such wide-ranging debt relief. And so the Supreme Court struck down that too-wide reading of the law.
In Canada, it is still the case that generally if the government has a great reason, courts will not pay too much attention to what the laws say or were meant to mean. If a regulator says it's necessary to get good results that's often the end of the question. An example of this in Canada is the Supreme Court-created
Oakes Test of 1986 that is used to interpret civil liberties. In Canada, if the government has a good enough reason that they claim then they can infringe on your civil liberties. Unsurprisingly, there's often a wide gulf between what the government claims is a good reason and what the people on the receiving end think is good enough. This legal approach shifts the focus away from the impact on the person and toward the benefit to the government.
After a century of the growth of regulators and what is called
the administrative state, there are a lot of regulators and a lot of vague laws in North America. It's often the case that authority can be found somewhere. But now, the US Supreme Court is beginning to push back and demand that the laws be specifically intended to result in what is claimed. Given the hugely influential role of American jurisprudence on the Canadian legal system, it's quite possible this idea will spread here too in time.
1980s vs. 2020s
What's the connection between student loans, carbon emissions caps, and cryptocurrency? What could possibly connect all of this? The answer: legal power without lawful authority. Although the law is subject to interpretation, recent cases in the US are showing a new way of thinking about the law that may impact cryptocurrency regulation.
Securities laws were passed with the idea of regulating shady share deals. But cryptocurrencies don't have shares. As I said earlier, the companies may have shares, but those are squarely within the law and have never been subject to any serious challenge. But securities laws make no mention of
assymetric encryption and the idea of global, decentralized networks of computers in which people do peer-to-peer transactions is completely alien to securities laws. Most of the concepts of cryptocurrency are novel and have nothing to do with how shares or stock markets work. Although there's superficial resemblances, and promoters/marketers have managed to confuse the public about this, there is obviously a huge difference between a unit of bitcoin and a share of Exxon Mobil. You can
buy (license) a digital song from Apple, but that's nothing like buying a share of Apple the company. Someone who has bitcoin gets nothing for their bitcoin, just the bitcoin itself.
Skeptics of the position taken by securities regulator might say that the situation is like the regulator getting involved in the making and distribution of cheese, when their proper place is to regulate the sale of shares in cheese companies.
Canadian regulators of many different stripes have all taken an interest in crypto. Last year, a press release was issued on behalf of three different regulators who all claimed an interest in what they call
crypto-assets. Not one of these regulators has had their principal legislation amended to give them this authority. One of the regulators is tasked with managing the bank account insurance system, another is a bank regulator, and the last one regulates certain financial institutions. One agency demands that developers of cryptocurrency
notify the regulator, even though there's no claim of authority or any regulatory framework in place! All of this despite the vast majority of cryptocurrency development happening outside of Canada's borders, with no regard to Canadian law or regulators.
Parliament can always make new laws. They haven't. There's no special crypto law that gives securities regulators authority. In fact, a draft law in Ontario to do exactly that still hasn't been introduced into the legislature.
Despite no new laws, securities regulators have launched many legal challenges against cryptocurrency developers and businesses. Most of these actions have been targeted at frauds, in part because frauds don't usually defend themselves. Startups and other weak targets have similarly been targetted for enforcement. It's notable that securities regulators haven't taken on Bitcoin as an entity. Yet they also won't quite issue a statement saying Bitcoin is outside of their regulatory authority. Almost every legal action that's been launched has been settled, which provides quick results to regulators but doesn't allow courts to test their claims. Often the terms are quite favourable to the companies. If it's true what's been alleged by the securities regulator, why then are these companies often given a mere slap on the wrist? Within this complex mix of facts and law, what is probably being seen is a fear that regulators have that perhaps they don't have the authority they claim to have.
It's possible that the current era will come to an end, with litigation in the US following the legal developments with student loans and carbon caps. This would pave the way for cryptocurrency to be seen on commercial terms, rather than on investment terms, which is how 99% of the economy and its products are treated. This is far from the
Wild West that many lawyers claim. Shopping at Walmart isn't the Wild West. Buying digital goods isn't the Wild West. There is still an enormous body of law that applies and many remedies available in the common law for those involved in cryptocurrency. Crypto = stocks is not even an easy analogy to make, given how different these things are.
Legal Changes And A Better World
To proponents of an ever larger state and all powerful regulators, any threat to their authority is upsetting. They view the recent US Supreme Court cases as a danger rather than an opportunity. But there's no danger in a society based on rule of law. Rule of law is good for everyone and there are great reasons why regulators should be limited to just what they have been specifically authorized to do. But beyond these theoretical reasons, there are practical benefits to people inside and outside of crypto if these legal changes come to pass in North America.
A move away from national securities regulators would also better fit the world of the 2020s than that of the 1980s. The world is globalized and software is now being made by distributed teams working all over the world. Ironically, a fear of securities laws has led many cryptocurrency developers to stay anonymous. This fear of regulators then creates a new problem for users, because the developers are anonymous and may be more likely to commit fraud. If people weren't living in fear of vague securities laws then they would be more willing to attach their names and reputations to projects, with a significant benefit to the public.
Today's people are Internet-native and their world doesn't end at the border.
Redirecting securities regulators back to their original mandate, the fighting of investment scams, would be a huge benefit to the millions of people in North America who are defrauded every year by unscrupulous people in the finance industry. There are enormous numbers of crooks operating out of fancy office towers and securities regulators need all the resources they can muster to go after them. This is the purpose of securities laws and the end of mission creep is a good thing for the accomplishment of the actual mission.
More freedom and clearer laws is a benefit that's hard to put a number on, but people will feel it when they see it. Forcing regulators to articulate their vision and pitch it to legislators is much harder than simply making up rules, but the deliberative process of making law is one that lets costs and benefits be aired and better solutions found. Clear rules for everyone is also better than providing exemptive relief on a case-by-case basis because it's a fair playing field for everyone. Entrepreneurs should be able to read the law and know what they must do, rather than hope that a regulator will grant them special dispensation.
Treating crypto as a product, and not as a security, is also a nice harmonization between the software-based rules of cryptocurrency and the global commercial system. People know the law of products and services much better than the law of investments and the rules for stock markets. The best law is the one that accords with the expectations of ordinary people and can be understood by them. Securities laws are very rooted in a particular place but cryptocurrencies aren't.
Recent changes in US Supreme Court jurisprudence, on topics seemingly unconnected to cryptocurrency, may cause a change in how the authority of securities regulators is judged with respect to cryptocurrency. If this approach is taken in Canada and the US, the result will be more freedom for software developers and consumers alike, who will no longer need to fear vague pronouncements and complex jurisdiction-by-jurisdiction regulatory approaches. To my knowledge, no one has yet drawn this connection. It'll take a few years to see how this plays out, but there may be a new resurgence in North American cryptocurrency development and use that follows from this trend.
There is another side to this issue. In fact, there's several. Administrative agencies like securities regulators were originally pioneered as more efficient than courts, and with the use of long-term technical specialists. As this is now the dominant system worldwide, there's certainly a case to be made that it worked out as intended and is the superior system. Whether or not it actually is, there is a new US legal movement afoot that puts the focus on the legislature and moves power away from regulators. There's nothing particularly unusual about this historically, but it hasn't been the dominant approach for the last few decades.
What proponents of the existing system would say about securities law and cryptocurrency varies, but they typically focus on anti-fraud/anti-scam, and strengthening the resiliency of the companies that act as significant spokes in the system (e.g. virtual currency dealers being registered as restricted dealers). I've made the case elsewhere on this blog for shifting anti-fraud/anti-scam to police forces, but at the moment they are under-resourced and securities regulators may genuinely have better knowledge in this area. Securities regulators are also well-placed to pursue frauds that are in the guise of investments. A movement away from securities regulators in the crypto space wouldn't mean these functions no longer are addressed, but rather that they're only addressed with legislative support, or they're addressed by other existing agencies like police forces.
There are many different ways to structure solutions to the problems created by criminals and shady businesspeople (and the grey area between them). The point of this post is not that these aren't problems, but rather that giving free reign to agencies to invent their own law may not be the best system. And it may not be the system that stands in a couple decades, if current American jurisprudence at the top spreads to other courts/adjudicative bodies in Canada and the US.