Advisors and broker-dealers who buy crypto currencies and crypto-related ETFs for customers can expect to draw the attention of SEC examiners, securities attorneys at Eversheds and Sutherland are warning.
The attorneys warned that the SEC is putting a focus on digital assets and that advisors need to be prepared. The scrutiny comes as both retail and institutional investor assets continue to flow into bitcoin and other crypto currency offerings and as prominent financial industry figures such as advisor Ric Edelman, founder of RIADAC, warn advisors that they will be left behind if they don’t initiate a crypto conversation with investors.
On the heels of a number of broker-dealers offering crypto ETFs, Morgan Stanley became the first big U.S. bank to join the proverbial crypto party March 17, with the announcement that it would allow advisors to offer three crypto ETFs to wealthy clients with at least $2 million in portfolio assets at the firm.
What can advisors expect when SEC examiners come calling? A focus on digital assets, including advisors’ justification for buying and holding digital assets, and how advisors are disclosing risks and calculating fees, Eversheds Sutherland partners Holly Smith and Bria Adams said in a new legal alert to clients.
First and foremost, advisors will need to justify that they understand digital asset and digital wallets and are meeting their fiduciary obligations, they said. That will include ensuring “that their diligence covers liquidity and volatility of any digital asset,” said the attorneys, who said advisors should pay close attention to the risk alert on digital currencies the SEC Division of Examination issued in late February.
SEC examiners “identified risks from recent examinations of investment advisers managing digital asset securities, as well as other digital assets and derivative products, for their clients either directly or indirectly through pooled vehicles,” the SEC said.
SEC staff “notes two reasons for its focus on digital assets: First, it believes digital assets that are securities involve unique risks, and second, it believes distributed ledger technologies involve distinct features that must be considered before developing compliance policies and procedures that are consistent with federal securities laws," the Eversheds partners said.
In particular, the staff points to the proper classification of digital assets, including whether a digital asset meets the definition of “security” under the federal securities laws, the Eversheds partners said. This is a particular grey area for all firms given that the SEC has brought ongoing litigation that is likely to more precisely set parameters regarding what digital assets are securities as well as the SEC’s reach.