Written By Matthew Flynn, Simon Grant, Kwang Lim and Maureen Ward
Welcome to Bennett Jones' quarterly Fintech in Canada update, where our fintech lawyers address timely issues shaping the industry. We look at what industry participants need to know in the areas of financial regulation, securities, commercialization of IT, AI, digital currencies, IP, data governance and privacy, tax, corporate finance, private equity, M&A and asset tracing.
In this Q2 2023 update, we look at:
- Considerations when considering the use of generative AI in a business.
- Potential changes to Canada's anti-money laundering and anti-terrorist financing rules.
- New registration requirements for money services businesses in British Columbia.
- The SEC filing against Binance.
Generative AI in Fintech
AI has captured the imagination of businesses big and small, across every industry, as a tool to boost efficiency and increase competitiveness by optimizing and unlocking value in data. But, for now at least, fintechs that are considering rolling third party generative AI into their technology stack or processes should be aware that this is not a simple 'plug and play' proposition.
Below are some common commercial contracting provisions that a fintech using third party generative AI might expect:
- Data permissions and hygiene: A provider of generative AI will want its users to warrant that they have sufficient rights, required consents and will otherwise be legally compliant in providing data for use in the AI service. Users will likely be asked to take responsibility for the accuracy, quality, integrity, legality, reliability, appropriateness and/or ownership of their data. Some AI providers may require that its users only submit data that is de-identified and /or that is strictly required for purposes of the AI service. These provisions will require upfront work (and expense) of AI users to vet and prepare their data before using the AI service.
Federal Government Opens Consultation on Expanding AML/ATF Regime to New Technologies
The federal government released a consultation paper in June 2023 on potential changes to Canada's anti-money laundering (AML) and anti-terrorist financing (ATF) rules that could, among other things, expand the application of AML/ATF regulation to:
- crypto-mixers and crypto-tumblers that mix together virtual currencies from different sources to enhance anonymity;
- decentralized finance (DeFi) products including distributed ledgers and decentralized financial tools;
- non-fungible tokens (NFTs) used as collectibles rather than for payment or investment;
- metaverse virtual reality products;
- fintech companies that provide technology-enabled financial services such as depositing cheques and paying bills;
- privacy-enhancing coins such as Monero; and
- tokenized assets representing ownership in real-world assets such as real estate, art or securities.
The consultation paper also considers whether businesses subject to AML/ATF regulation should be able to seek short term exemptive relief from FINTRAC regulation in order to test out new technologies and compliance methods (perhaps similar to exemptive relief available from securities regulators).
The consultation period closes on August 1, 2023.
Money Services Businesses in British Columbia Subject to New Registration Requirement
New legislation in British Columbia will require money services businesses to register and comply with new provincial requirements. The definition of "money services business" under the new British Columbia act mostly follows the federal definition, although dealing in virtual currencies is not a "money service." Read more about the changes in our blog, New Legislation Will Require Money Services Businesses in British Columbia to Register.
SEC Filing against Binance
On June 6, 2023, the U.S. Securities and Exchange Commission (SEC) took a significant step by making a filing against Binance Holdings Ltd. (Binance) and Binance.US and seeking, among other things, a temporary restraining order freezing assets and directing the defendants to repatriate assets held for the benefit of customers of the Binance.US crypto trading platform. As noted in the SEC press release on June 5, 2023, the SEC charged Binance, which operates the largest crypto asset trading platform in the world, Binance.com, U.S.-based affiliate BAM Trading Services Inc. (“BAM Trading”), which, together with Binance, operates the crypto asset trading platform, Binance.US and their founder, Changpeng Zhao, with a variety of securities law violations.
Among many strongly worded allegations, the SEC alleged that:
- despite claims by Zhao and Binance that they were not operating in the United States, they were secretly allowing high-value U.S. customers to continue trading on the Binance.com platform;
- despite claims by Zhao and Binance that Binance.US was created as a separate, independent trading platform for U.S. investors, Zhao and Binance secretly controlled the Binance.US platform’s operations behind the scenes;
- BAM Trading and BAM Management US Holdings, Inc. misled investors about non-existent trading controls over the Binance.US platform, while Sigma Chain, an entity which is an active trader on the Binance platform and whom the SEC alleges is ultimately owned and controlled by Zhao, engaged in manipulative trading that artificially inflated the platform’s trading volume;
- the defendants concealed the commingling of billions of dollars of investor assets and sending them to a third party, Merit Peak Limited, which is also owned by Zhao; Sigma Chain’s and Merit Peak’s activity on the Binance.US platform, and their undisclosed relationship with Zhao and Binance, have involved and continue to present conflicts between Zhao’s financial interests and those of Binance.US platform’s customers; and
- violations of critical registration-related provisions of federal U.S. securities laws occurred.
On June 16, 2023, the SEC announced that an agreement has been struck between the SEC and the defendants, which permits Binance.US to continue its operations notwithstanding the fraud-based charges levied against it by the SEC, provided that the defendants repatriate to the United States assets held for the benefit of customers of the Binance.US crypto asset trading platform. Under the agreement, BAM Trading is prohibited from spending other than in the ordinary course of business. The agreement is intended to ensure that Binance.US customers are permitted to withdraw their assets from the platform and that those assets that remain on the platform are protected and remain in the United States pending the outcome of the litigation. The order also prohibits all of the defendants from destroying records, requires all of the defendants to submit expedited sworn accountings
While this development is remarkable, presiding Judge Amy Jackson had refused to grant the temporary restraining order originally sought by the SEC on June 6, 2023, instead urging both parties to come to an agreement that would protect consumer assets without the need to close down the crypto asset trading platform.
Binance.US accused the SEC of “regulation by enforcement”, which is a tactic that various actors in the crypto industry have previously asserted as being an unfair way to address the industry. Further, on June 26, 2023 the Judge denied a motion by the defendants wherein they sought to stop the SEC from making public statements. The defendants had alleged that the press releases made to date were misleading and had the potential of “tainting the jury pool” and introducing “unwarranted confusion into the marketplace.”
We continue to review the various legal steps occurring in this case, including their impact, if any, on the regulation of crypto-asset trading platforms in Canada and the Canadian Securities Administrators Staff Notice 21-332, which we discussed in our Q1 2023 Fintech update. We remain available to assist in addressing any crypto-disputes with a Canadian connection.
Bennett Jones' Fintech Team
Our Fintech team helps clients navigate the evolving digital economy and regulatory landscape and seize strategic opportunities. With strong, multi-disciplinary expertise and deep bench strength, clients rely on us for our creative problem-solving and for our practical, business-first approach.
To discuss how our fintech team can assist you, please contact one of the authors.