“The SEC has taken a very deliberate approach in this space,” said Peter Van Valkenburgh, director of research Coin Center, a Washington-based advocacy group. “I think they are just trying to get a handle on the large ecosystem.”
Scrutiny of how hedge funds value assets is common in SEC examinations because it directly impacts the level of fees that firms charge investors for managing their money. The more investments are worth, the higher the fees.
For ICOs and cryptocurrencies, hedge funds’ pricing methods are arguably even more worthy of attention because most trades occur on venues with limited transparency that lack federal oversight. The SEC highlighted some of the risks in a March 7 statement when it said unregistered crypto-trading platforms probably don’t have the same protections against fraud and manipulation as the nation’s stock exchanges.
Safeguarding Investments
Another target of the SEC’s inspections unit is how crypto-fund managers safeguard their investments and clients’ money, the people said.
The agency wants to know whether funds are complying with rules requiring firms to hold assets with qualified custodians, usually banks or brokerages, as a way to prevent misappropriation. This issue is particularly vexing for digital tokens because many are held in virtual wallets, which have been subject to hacks.
The SEC has also been asking funds about relationships they might have with companies they’re investing in, according to one of the people. Specifically, the agency has questioned whether firms have properly disclosed any potential conflicts of interest, such as fund managers holding personal stakes in ICOs, the person said.
The SEC has issued at least one subpoena asking a hedge fund about its investment in an ICO, one of the people said. And in a separate inquiry, agency enforcement attorneys have questioned some investment banks about their involvement with token sales, another person said.
Dodging Registration
Another SEC concern is what’s known as a Simple Agreement for Future Tokens, an investment structure that many startups have used to raise capital by selling rights to tokens that haven’t yet been issued, one of the people said. Some companies have used SAFTs to try to avoid having to register their ICOs with the SEC.
But the agency has taken a hard line. Clayton, the SEC chairman, told a group of lawyers in November that he hasn’t seen a single ICO that doesn’t have the “hallmarks of a security.”
This article was provided by Bloomberg News.