Cryptocurrency is one of the financial industry’s most trending topics. But the increase in popularity has also brought an increase in regulatory scrutiny.
What does this mean for compliance? What do investment advisers need to know?
Recently, Brian Roberts and I hosted a live webcast discussing recent developments in the regulation of digital assets, and how investment advisers’ compliance programs can adapt to manage related risks.
During the webcast, we received several interesting questions from the audience. Below is our take on a few of the most commonly asked questions:
- What personal trading policies should a registered investment adviser have for coins and tokens?
We generally recommend that clients take a conservative approach and treat all digital assets that were sold in initial coin offerings or similar presales as “reportable securities” subject to the reporting and monitoring provisions of Rule 204A-1 under the Investment Advisers Act of 1940 (“Advisers Act”).
- Should investment advisers require pre-clearance of employee personal transactions in digital tokens or coins?
Investment advisers primarily focused on the digital asset space are likely to face heightened SEC scrutiny, at least in the short term, and these advisers should consider preclearance of these transactions as a result of the relative illiquidity of many digital assets. In the long term, advisers that invest primarily in traditional assets but that have some exposure to digital assets should also consider adopting policies that account for this. Finally, most initial coin offerings are likely to be viewed by the SEC as analogous to initial public offerings, which must be precleared regardless of the adviser’s investment strategy.
- How does an investment manager that allows employees to invest in ICOs and/or cryptocurrencies verify employee transactions and investment holdings?
To the extent an employee invests in digital assets through an institutional third party, she/he will likely be able to download a summary of periodic activity that can be provided to a compliance officer. If the employee is not using an exchange or custodian, or the available reports are incomplete, a CCO would rely on the activity and holdings as disclosed directly by the employee, along with an attestation that this disclosure documented all of the trading activity as required the by the firm’s code of ethics.
- Can an investment adviser accept investments or subscriptions into a private fund that invests in digital assets via bitcoin, ether, etc., or does this investment need to be converted into US dollars first?
An adviser should carefully consider (and potentially consult with counsel when deciding) whether to accept investments in cryptocurrency. Some investment advisers will accept such in-kind contributions. These funds, however, may not have passed through the U.S. banking system, which may create heightened risks of money laundering and questions about the ultimate sources of the invested capital. Advisers whose AML policies only consider U.S.-dollar investments should determine whether these need to be revised to address the increased AML risk created by acceptance of in-kind subscriptions in the form of digital assets. Advisers should also consider amending their valuation policies and procedures to prescribe a fair and repeatable process for valuing such contributions.
- If a firm is an exempt reporting adviser (“ERA”), is custody still an issue?
Rule 206(4)-2 under the Advisers Act, the Custody Rule, does not apply to ERAs. Client accounts managed by an ERA will not be subject to the Custody Rule. ERAs, however, may wish to consider adopting policies that address the concerns of the Custody Rule, and consider implementing safeguards (e.g., sharding, encryption, air-gapping) to help protect their private keys.
Miss the Webcast? Replay it Here.
For access to the full Cryptocurrency Regulation for Investment Advisers discussion, listen to the on-demand archive here.
Below is an outline of what was discussed during this one-hour session:
- Why regulate digital assets?
- A review of SEC digital asset enforcement over the past year
- SEC crypto currency sweep exams
- Digital asset investors’ evolving attitude toward regulation
- Characteristics of coins vs. tokens
- Practical considerations for Chief Compliance Officers (CCOs)
If you have any further questions about this webcast or would like to learn more about ACA’s services for Cryptocurrency Advisers, please contact Ryan MacDonald at email@example.com, Mike Seery at firstname.lastname@example.org, or Brian Roberts at email@example.com.
About the Authors
Mike Seery joined ACA in December 2017. As a Senior Principal Consultant, he helps hedge fund, private equity fund, and other SEC-registered investment advisers create and maintain best-in-class regulatory compliance programs. Mike advises clients on complex regulatory issues, including portfolio valuation, expense allocation, soft dollars, and expert networks. Before joining ACA, Mike was a Director at Duff & Phelps and a predecessor entity, where he helped investment advisers register with the SEC and create compliance programs in accordance with SEC best practices. He led operational assessments, annual reviews, and mock SEC exams. He advised clients throughout the SEC examination process, drafted responses to staff questions, prepared employees for interviews, and responded to examination findings. Previously, Mike worked in financial restructuring, where he advised companies and creditors in bankruptcy proceedings and out-of-court reorganizations. Mike started his career in investment banking, where he worked in M&A advisory at Lehman Brothers and fixed-income trading at Merrill Lynch. Mike earned his Bachelor of Arts degree in History from Yale University and his MBA in Finance from UCLA.
Brian Roberts joined ACA in March 2014. As a Consultant in the Investment Adviser and Private Funds group, Brian leads and participates in mock SEC inspections and compliance program reviews for clients. He also helps SEC-registered investment advisers and exempt reporting advisers develop and implement policies and procedures tailored to their businesses. In addition, Brian manages recurring client relationships and participates in secondment programs. He also takes part in numerous ACA internal projects and serves as a member the firm’s Cryptocurrency Research group. Prior to his work at ACA, Brian represented private fund managers in transactional and regulatory matters as an attorney. Brian earned his J.D. from Boston University and his B.A. in philosophy from the University of California, Berkeley.