The Securities and Exchange Commission is probing investment advisers for potential misconduct involving cryptocurrencies, signaling a new direction in its oversight of the emerging market, according to three people familiar with the matter.
The regulator is focusing on how investment advisers registered with the agency are storing the cryptocurrency assets they hold, as well as on possible price manipulation, and the digital currencies’ vulnerability to cyberattacks.
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The investigation marks an escalation of the SEC’s scrutiny of the digital currencies. In the last year, the agency has halted a number of initial coin offerings, and Chairman Jay Clayton has warned that it will vigorously police the industry.
Notably, the SEC is looking beyond the type of fraud cases that it has brought so far and is now hunting for violations involving the agency’s custody rule for assets, valuation and cybersecurity, said the people, who requested anonymity to speak freely about the agency’s efforts.
SEC spokesperson Ryan White declined to comment.
After the agency’s enforcement division earlier this year sent out subpoenas and informal requests for information about ICOs, the SEC’s Office of Compliance Inspections and Examinations began asking investment advisers nationwide about cryptocurrencies, the people said.
The SEC regulates investment advisers who manage $100 million or more in client assets. The advisers typically getting into cryptocurrencies include big institutional investors such as private equity funds or hedge funds.
For stocks and bonds, the SEC’s custody rule says an investment adviser must usually keep the securities at a bank or brokerage firm. But cryptocurrencies are stored in digital wallets, and only a handful of companies offer cryptocurrency custody services. Still, investment advisers who don’t have policies in place detailing the custody of their crpytocurrencies risk trouble with the SEC, the people said.
Valuing cryptocurrencies is another concern for the SEC. Unlike stocks, cryptocurrencies do not trade on regulated exchanges. In denying various applications for Bitcoin exchange-traded funds, the SEC has said it has concerns about price manipulation for cryptocurrencies.
Cybersecurity worries were fueled by a June report by South Korean based-Coinrail, a trading and wallet venue, that $40 million was stolen from customer accounts. Over the past year, cryptocurrency exchanges have lost $861 million to hackers, according to recent research by cybersecurity firm Group-IB. The loss of a digital wallet’s private key can render an investor’s cryptocurrencies unrecoverable.
For now, advisers don’t have a lot of guidance from the SEC about how to report cryptocurrency investing to remain in the agency’s good graces.
In lieu of SEC guidance, “advisers should think about investments in crypto assets the same way they think about any investments, through the lens of their fiduciary duty and compliance programs,” said Gail Bernstein, general counsel at the Investment Adviser Association, a trade group based in Washington that represents more than 640 SEC-registered investment advisory firms.
“Typically, after a sweep of this type, the SEC staff will publish its findings and observations, and that can provide very helpful guidance for advisers as they consider their compliance obligations,” she said.
The SEC poses a danger to those who jumped into cryptocurrencies without analyzing the risks, said Timothy Spangler, a partner with law firm Dechert LLP in California. “I think where the SEC is concerned is where there is evidence that the registered investment adviser didn’t spend enough time thinking about the risks,” he said.
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