At the inaugural FinTech Forum that the Securities and Exchange Commission (SEC) sponsored on May 31, the investment management panel tackled the legal, risk and compliance challenges facing the SEC and market participants with respect to digital assets. Among other things, the panel analyzed issues such as regulation of custody of digital assets by investment companies and investment advisers, noting that proper, well-structured and balanced regulation is necessary for safeguarding the integrity of the capital markets and critical for harnessing continued innovation in FinTech.
In her remarks introducing the investment management panel, Dalia Blas, the Director of the Division of Investment Management, said that while innovation in the financial markets has fueled the success of the country’s economy, the SEC’s staff has identified significant legal and investor protection issues with regard to custody and cryptocurrency-related holdings under the Investment Company Act of 1940. Protecting investors, an enduring goal of the Commission, should and will continue to play a key role in regulating the industry going forward.
What did the panel highlight as vital investment management considerations around cryptocurrency holdings and digital asset custody? Read on for a digest of some of the key takeaways that were highlighted in the dialogue.
- Define your investment goals and take a lockstep approach to legal. From a lawyer’s perspective, the first thing you should identify is your client’s our goals. These goals, of course, largely depends on the role your market participant plays. Whether you are an entrepreneur, hedge fund operator, service provider or an investment manager, your specific goals come with various legal and practical implications. The current landscape can be a minefield of laws – rules and regulations involving federal securities laws regulated by the SEC and the Financial Industry Regulatory Authority (FINRA), commodity laws regulated by the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA), banking laws regulated by the Comptroller of the Currency and the Board of Governors of the Federal Reserve, not to mention myriad of state laws and regulations. There are potential risks and challenges, especially when they are unknown, so it is important to speak to your legal advisor to help navigate you through nuanced legal strategies that map back to your investment objectives.
- Custody-related rules should be thoughtful and creative – one size does not fit all. Custody is perhaps the most vexing issue that the SEC is currently addressing. As a fiduciary, an investment adviser is responsible for keeping assets protected, accountable and verifiable, but what is a qualified custodian when it comes to digital assets? When thinking about regulations, there needs to be careful, creative thinking involved in the process for it to apply broadly and offer protection without it being too burdensome. The rules shouldn’t try to prescribe specific technological standards as what may apply for one custodian may not work for another, and the rapid pace of innovation may deem the standards outdated in a few years’ or even months’ time. Moreover, it is important to use a principles-based approach that utilizes controls and a combination of physical and procedural safeguards.
- Crypto is here to stay and so is the trust in the regulatory market. In any marketplace, you need to have trust. Evidently, we are seeing demand from regulators, auditors and the investor community for more trust and assurance as the cryptocurrency market becomes more prevalent. This means that the market is naturally setting the stage to help guide regulations as a way to enhance transparency. There is a light at the end of the tunnel. The foundational elements for sound regulations already exists – it is just a matter of reaching it. With an optimistic mindset, we need to continue to keep our eyes open, the dialogue running and work together while respecting the regulatory process and extending timelines if necessary.